Magic Software Enterprises Ltd

NASDAQ:MGIC

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2024 Fourth Quarter and Full Year Financial Results Conference Call. Magic's fourth quarter 2024 earnings release was issued before the market opened yesterday, and it has been posted on the company's website at www.magicsoftware.com. [Operator Instructions] With us on the line today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Bernstein; 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 yesterday. 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 Bernstein, CFO of Magic Software. Please go ahead.

Thank you, operator, and thank you, everyone, for joining us today as we report our fourth quarter and full year 2024 financial results. Before diving into the summary of our financial performance for the year, I would like first to address our recent announcement and its implications.

On March 10, we announced that we entered into a nonbinding memorandum of understanding with Matrix IT, a leading public Israeli IT services company whose shares are traded on the Tel Aviv Stock Exchange as well as a subsidiary of Formula Systems, our controlling shareholder. According to the provision of the MOU, we agreed to negotiate a definitive agreement regarding a merger under which Matrix will acquire our entire share capital on a fully diluted basis by way of a reverse triangular merger, upon completion of which we will become a private company wholly owned by Matrix.

The consideration to our shareholders will be exclusively in the form of Matrix ordinary shares, which was based on the relative valuation of both companies such that immediately following the merger, Magic shareholders will hold 31.125% of the issued and outstanding share capital of Matrix and the shareholders who held Matrix shares prior to the merger will hold 68.875%, both on a fully diluted basis. The combined market capitalization of the combined entity based on share prices prior to the merger announcement stood at $2.1 billion, which implies for a 13% premium on Magic share price prior to the announcement. As of today, the combined valuation has risen to $2.3 billion.

With respect to dividend distributions following the announcement, we and Matrix may continue distributing dividends in accordance with the provisions of our respective distribution policies and in any event, not more than 75% of our respective net profit attributable to our shareholders for the year 2024 and for the first and second quarter of 2025 without it affecting the agreed relative valuation ratio. Following the merger, Magic's ordinary shares will be delisted from NASDAQ and from the Tel Aviv Stock Exchange and Matrix ordinary shares will continue to be traded exclusively on the Tel Aviv Stock Exchange. It should be mentioned that in accordance with statements made by Matrix management, Matrix do intend to explore the possibility in the future of relisting the combined entity shares on NASDAQ in the short or to long-term period, allowing time for Matrix to solidify its joint operation with Magic in the U.S. market and for investors to gain greater familiarity with Matrix business and leadership.

For those who are less familiar with Matrix, it is Israel's leading IT services company as demonstrated for the 19 years in a row in research report on the Israeli IT market published by the research companies, IDC and STKI. Matrix currently employs approximately 11,570 software, hardware, integration engineering and training personnel, which provide advanced IT services to hundreds of customers in the Israeli market as well as to customers in the U.S. market. Matrix executes some of the largest IT projects in Israel. It develops and implements leading technologies, software solution and products. Matrix provides infrastructure and consulting services, outsourcing, offshore, nearshore training and assimilation services.

Matrix represents and market leading software vendors among its customers are most of the leading Israeli organizations and companies in the industry, retail, banking and finance, education and academy, high-tech and start-ups, transportation, defense, health care and the governmental and public sectors. Matrix also market sales and distribute software solutions and hardware representing a wide variety of software vendors from Israel and around the world.

In light of the fact that Formula System is considered a controlling shareholder of both our company and Matrix since it holds approximately 47% and 48% of the outstanding ordinary shares of each respective company, our Board of Directors in accordance with Israeli companies law, appointed an independent committee who established orderly work procedures to independently evaluate the deal conduct a thorough and comprehensive work process, including an analysis of our available alternatives, including the option not to proceed with the merger and engage in negotiations with Matrix independent committee regarding the terms of the merger.

Following the negotiation, the MOU was approved by the committee and by our Board of Directors without the presence of any of the representatives of Formula Systems based on the committee's recommendation and following its approval. This marks a pivotal moment in our company's journey, one that we believe will create tremendous value for our investors, customers and employees alike. This merger is a strategic milestone that brings together the leading technology firms to form a global IT powerhouse. The combined entity is expected to be among the top publicly listed IT service company, both in the U.S. and in Europe and will benefit from increased scale, operational synergies and expanded service portfolio.

From an accounting perspective, the merger will be reported under the pooling of interest method in Matrix's financial statements. This means all assets and liabilities will be recorded at book value. No additional goodwill, no identifiable intangible assets will be recognized upon the acquisition. And as such, there would be no subsequent amortization of intangible assets following the deal on the combined entity's report. We believe this structure maximized shareholders' value by ensuring a transparent and fair valuation process while maintaining a strong financial position for the combined entity.

As for the combined entity's 2024 key pro forma financial indicators based on the financial results of both companies, the merger will result in a combined company generating over $2 billion in annual revenues with approximately 17% of revenues from the U.S. market and 78% from Israel. Gross profit of $382 million with an 18.6% gross margin. Operating income of $183 million, reflecting approximately 9% operating margin with an EBITDA of approximately $217 million, reflecting EBITDA margin of over 10%. Net income attributable to noncontrolling interest of $110.6 million with a 5.4% net margin.

Post-merger, the combined entity will employ over 15,000 professionals operate across dozens of countries and serve a customer base of over 6,000 clients. The key driver of growth for Magic within the merged organization will be cross-selling opportunities, leveraging Matrix's extensive product and service offering to expand Magic's reach and revenue potential.

In summary, this transaction is far more than just a combination of 2 companies. It is a transformational move that would strengthen Magic's market position, expand its capabilities and enhance value for its shareholders. The combination of Magic and Matrix is expected to generate significant benefits through increased scale, complementary geographic presence and a broader product and service portfolio. It will create a larger and more resilient IT service and software solution organization, enhancing our position with large enterprise clients, particularly in the Israeli and the U.S. market. It will allow us to better position to compete on a global scale, leveraging a stronger brand, a larger customer base and a broader suite of solutions and service offerings.

We possess a well-established international presence already today, particularly in the U.S., while Matrix holds a dominant market position in Israel. The merger will allow both companies to leverage each other's strength to expand geographic reach and enhance international client engagement and delivery with clients from both companies, benefiting from a broader spectrum of technology solutions, software products and IT services under a single unified organization. Magic customers will gain access to a broader, more comprehensive range of IT services and solutions. Magic's low-code, no-code application development platform will be complemented by Matrix IT service and system integration expertise.

Although Magic will be delisted from trading on NASDAQ, the combined entity will continue to be traded exclusively on the Tel Aviv Stock Exchange with the potential to be included in the prestige Tel Aviv 35 share Index that tracks the performance of the 35 largest companies by market capitalization listed on the Tel Aviv Stock Exchange, serving as a barometer for the Israeli economy. The list is updated twice a year in August and in February. And once and if the merger is concluded, we would have the potential to be included in it.

Looking ahead, while the merger possesses -- the merger process is underway and is expected to continue at least into the third quarter of the year, we remain focused on seamless execution, maintaining business continuity and driving long-term shareholder value, and we'll continue to update you as we achieve key milestones in this process.

Turning to our financial performance for the quarter. Revenue in the fourth quarter of 2024 increased to $142.6 million, up approximately 13.6% from the fourth quarter of 2023. This quarter, despite fewer billable days in Israel accounting for 5% of revenues compared to the same period last year due to the timing of the Jewish New Year holidays resulted due to the strong execution in a revenue increase of 15.5% all organic, primarily resulted from strong demand for our cloud DevOps AI services, along with continued strong demand for our services in the defense sector.

Our North American operation increased by approximately 14%, resulting from addition of Theoris Inc. acquired in April of 2024. Excluding Theoris, revenues in North America remained stable. And while the U.S. market has yet to show a full recovery, we anticipate positive momentum fueled by economic improvement. We are confident that we are on the right path and momentum is building. 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 service offering are critical as customers continue to automate and digitize their systems and products. And while some of our U.S. customers were and may still be facing macro and company-specific challenges, the 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.

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 innovative software solutions 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 made it our vision to help business 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 development meet the highest standards of performance, scalability, security and reliability.

Our suite of managed cloud services is designed to address critical aspects of cloud operation 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 revenues from cloud services increased in 2024 for the whole year by 45% year-over-year. We have over 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 the fourth quarter geographic revenue breakdown. In the fourth quarter of 2024, our revenues in North America increased by 14.2% from $51.3 million to $58.6 million. Excluding M&A, our revenue in North America remained unchanged and accounted for 41% of our overall quarterly revenue. Revenues from our Israeli operations amounted to $62.7 million, up by 15.5% compared to $54.3 million reported in the same period last year. 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 allows us to fully compensate for the slowdown we experienced from the second half of 2023 in North America. Revenues from our Israeli operations accounted for 44% of our overall quarterly revenues.

Turning now to profitability. Our non-GAAP gross margin for the fourth quarter of 2024 amounted to 30.3% of revenues or $43.2 million compared to 30.8% in the corresponding quarter of 2023 or $38.6 million for the same period last year. The breakdown of our revenue mix for the fourth quarter of 2024 was approximately 17% related to our software solutions with a gross margin of approximately 62% and 83% related to our professional services with a gross margin of approximately 23.8%. Our non-GAAP operating income for the fourth quarter of 2024 increased by 6.1% to $18.8 million compared to $17.7 million in the same period last year.

Financial expenses. During the quarter, we had financial expenses of $1.5 million compared to $1.9 million. The decrease in our financial expenses is mainly resulted from the continued decrease of our overall financial debt during 2024 from $82 million to $59 million at the end of the year. Net income attributed 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 role in such entities, we are allocating a portion of our net income to these minority shareholders.

Non-GAAP net income attributable to noncontrolling interest increased to $2.1 million compared to $1.5 million for the same period last year. Our non-GAAP net income for the fourth quarter decreased by 0.5% to $11.5 million or $0.24 per fully diluted share compared to $11.6 million or $0.24 per fully diluted share in the same period last year.

Turning now to full year results for the 12 months that ended December 31, 2024. Revenues for the whole year increased by 3.3% to $552.5 million compared to $535.1 million in 2023. Our non-GAAP gross margin for the year amounted to 29.4% or $162.6 million, down 20 basis points from 29.6% or $158.8 million in 2023. The breakdown of our revenue mix for the whole year was 18% related to our software solution with gross margin of approximately 64% and 82% related to our professional services with a gross margin of approximately 22%. 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.

Non-GAAP operating income for the year increased by 2.5% to $73.6 million compared to $71.8 million in the same period last year. Non-GAAP net income attributable to noncontrolling interest increased to $8.2 million compared to $7.2 million in 2023. Non-GAAP net income attributed to Magic Software shareholders for the year decreased by 5.7% to $45.7 million or $0.93 per fully diluted share compared to $48.4 million or $0.99 per fully diluted share in the same period last year.

Turning now to the balance sheet. As of December 31, 2024, our cash and cash equivalents and short-term bank deposits amounted to approximately $112.8 million compared to $106.7 million as of December 31, 2023. Our total financial debt as of December 31, 2024, amounted to approximately $59 million compared to $81 million as of December 31, 2023. Our cash flow from operating activities for the year ended in 2024 was $74.7 million compared to $69 million for the same period last year.

In accordance with our dividend distribution policy, our Board of Directors declared a semiannual cash dividend in an amount of $0.327 per share and in an aggregate amount of approximately $16.1 million, which, together with the dividend distributed for the first half of 2024 in an amount of approximately $11.5 million reflects 75% of Magic's net income attributable to its shareholders for the year.

In closing, I would like to turn our guidance for 2025. As we are witnessing a healthy demand and developing a growing pipeline to deliver continued growth in 2025, we anticipate revenue in the range of between $593 million and $603 million based on current currency exchange rate, reflecting an annual growth of 7.3% to 9.1% compared to the prior year. Magic Software has navigated a dynamic environment with the resilience and adaptivity. Our expanding AI-driven solution, cloud transformation expertise and strong execution have positioned us for continued success. With the Matrix merger on the horizon, we believe that the combined entity will be a global leader in the IT services, delivering strong shareholder value, enhanced customer solutions and greater innovation. We remain confident and excited about the road ahead, and we'll continue executing our strategy to drive sustainable long-term growth.

I will now turn the call over to operator for the questions.

[Operator Instructions] The first question is from Chris Reimer of Barclays.

Congratulations on a strong quarter. I was wondering if you could talk about some of the drivers behind your guidance. What are some of the things that are giving you the confidence in the 8% midpoint for 2025?

Basically, as you saw through the year, we managed to improve our results and increase our backlog from one quarter to the other. We are starting -- we basically finished Q4 very strong. In terms of our cloud services, our operations in the defense sector, all of these, the potential that we have and our expectation to create new revenues coming from AI consulting deals, all of that for us are the pivotal instrument to increase our revenues also for next year.

And how should we be looking at expenses given the higher growth environment?

I'll say that on the payroll side of the business, which is the significant cost item on our P&L, things are relatively stable, though again, we start to see the improvement in the Israeli market and the return of capital investment to the Israeli market now that things seems to be a little bit more stable to create again some pressure on payroll. You need to remember that employees for the last 2 years were pretty stagnant in their payroll increases. But I think that over the years, we managed to show that we are -- we managed to maintain our operational margins and see that we control costs in the same level that we improve the top line of the company.

The next question is from Maggie Nolan of William Blair.

I was hoping to take a little bit more long-term view. I would love to understand for the joint company, if possible, where the kind of long-term growth drivers are in terms of end markets or geographies? And if you're unable to give additional color there, maybe from the Magic perspective, what you think will really carry the business over more of a multiyear period?

I will take that. I think that the main driver for the growth going forward is basically based on the infrastructure of MAGIC because Magic has all the infrastructure ready in order to boost other markets. Matrix, of course, can bring to the table all the relationship with all the big and giant vendors and of course, expand the offering that the Magic operation can deal with. And as a result, bring a lot more business.

And how do you expect your AI solutions to evolve over the next year or so? And anything you can share with us in terms of expectations for adoption levels of AI maybe in the next year versus what you saw in the past year and how you see that progressing?

Okay. So all in all, we are not treating this as a start-up company. We have our own product that we develop that should help organizations to approach AI technologies into their way of doing business. We see that the big corporations are still hesitating, trying some small stuff in order to check it and to see how it works. But at the end, we will transform this into business with a big organization. This is the audience that we work with and this is what we target. And by the way, this is the easiest way for us because most of them do not know how to approach that.

And from the technology point of view, I can add that we are looking -- as a vendor of development platform, looking deeply into the kind of dramatic change that the Gen AI SDLC is bringing to the software development life cycle and taking our low-code tools to actually their next generation of prompt-based tooling and speed up development, which we do believe that the Gen AI development method will revolutionize the industry of software development, and we utilize it internally for ourselves as well at the moment.

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

So thank you, everybody, for joining our call with another quarter that the business is improving. I know that you are maybe excited, maybe concerned by the news. But all in all, it should boost both companies and can give a really significant upside. So thank you, and hope to see you in our next call. Thank you.

Thank you. This concludes the Magic Software Enterprises Ltd. 2024 Fourth Quarter Results Conference Call. Thank you for your participation. You may go ahead and disconnect.