Magic Software Enterprises Q4 2023 Earnings Call Transcript

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March 13, 2024

There are 5 speakers on the call.

Operator

Software Enterprises 2023 4th quarter and full year financial results conference call. Magic's 4th 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's CEO, Mr.

Operator

Guy Bernstein Magic's CFO, Mr. Asaf Bernstein 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 content of this call.

Operator

Magic expressly disclaims any obligation to update or revise any of these forward looking statements, whether because of future events, new information, 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.

Operator

Assaf Bernstein, CFO of Magic Software. Please go ahead.

Speaker 1

Thank you, operator, and thank you everyone for joining us today as we report our Q4 2023 financial results. During the call today, I will review highlights from our Q4 results and provide an overview of our outlook. Revenue in the Q4 of 2023 decreased to $125,500,000 down approximately 14.7% from the Q4 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 3 months ended December 31, 2022, revenues for the Q4 of 2023 would have decreased by approximately 11.2% compared to the Q4 of 2022 to $130,600,000 $5,000,000 more higher than our reported revenue figure for the quarter.

Speaker 1

As we described in the Q3 results conference call on November 14, the reduction in our 3rd and 4th quarter revenues was caused primarily by two factors. 1, 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 4th quarter, which has hurt our Israeli shekel denominated operations by $5,600,000 for the 4th quarter and $22,900,000 for the year. And second, a substantial and unexpected decline in demand for our professional services from several of our important U.

Speaker 1

S.-based blue chip customers, which without any advanced 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 part 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 primarily 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 1700 Israeli employees. We keep on standing with Israel in its fight and wish our employees while fighting and the entire Israeli Armed Forces continued success at eliminating the terrorist organization that planned and conducted the brutal murder of 1400 Israeli civilians and continues to hold 134 Israeli hostages. The absence of Israeli employees who were drafted for active military services since the beginning of the war on October 7, together with the decline in demand for our software services from several of our important U.

Speaker 1

S.-based blue chip customers and the continued challenging macroeconomic environment of high interest rate, persistent inflation and reduced capital spending have caused us to report significantly lower revenues for the Q4 and for the second half compared to the same period last year. Having said that, I would like to highlight that our 4th quarter revenues have reached the higher end of our 4th 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 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 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.

Speaker 1

In the Q4 of 2023, our non GAAP operating margin held strong at approximately 14.1% of our revenue, 80 basis points higher compared to the margin during the first half of twenty twenty three 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 drive 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 demand for our innovative software solution and services. We similarly continue to see excellent execution by our teams.

Speaker 1

Setting aside the factors that slowed 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 1st days of Magic Software, we have been characterized by our ability to take complex IT processes and maintenance systems. Today, we put our focus on helping our clients to transition seamlessly to the cloud, enhance their software as a service capabilities and deliver exceptional 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 true SaaS excellence.

Speaker 1

Like many others, we recognize that the cloud is not just technology shift. 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 standard of performance, scalability, security and reliability. Our suite of managed cloud services which include services such as NOC as a service, SOC as a service, DevOps as a service, FinOps as a service and much more are tailored to address critical aspect of cloud operation operation and client business continuity, empowering our clients to focus on the core competences 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 due to the increasing complexity of cloud environment and the need for specialized expertise.

Speaker 1

As of today, Magic has over 300 logos consuming its managed cloud services. What set 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 professional leverage their expertise across the 3 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.

Speaker 1

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 4th quarter financials, in the Q4 of 2023, our revenues in North America amounted to $51,300,000 which is approximately $30,400,000 or 37% lower compared to the Q4 of 2022 and $7,200,000 or 12 percent lower compared to the Q3 of 2023, mainly due to additional CapEx 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 decision resulting in a decrease of close to 600 of our U. S.

Speaker 1

Specialists compared to the respective quarter last year. Revenue from our Israeli operation amounted to $54,300,000 up by 9.5% compared to $49,600,000 reported for the Q4 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.

Speaker 1

On a constant currency basis calculated based on the average currency exchange rate for the 3 months ended December 31, 2022, revenues for the Q4 of 2023 of our Israeli operation would have increased by additional $5,600,000 to $59,900,000 overall, reflecting a year over year growth of 20.8 percent in late term. 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 to 20 percent 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 experienced in North America. Turning now to profitability, despite the significant currency headwinds and the problems with our U. S.-based revenue during the second half of twenty twenty three, we were nevertheless able to increase our gross margin for the Q4 of 2023 by 150 basis points to 30.8 percent of revenues or $38,600,000 compared to 29.3% in the corresponding quarter of 2022, in which it was $43,200,000 The breakdown of our revenue 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%.

Speaker 1

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 solution and 58% related to our professional services compared to 39% 61% in the same period last year. Our non GAAP operating income for the Q4 of 2023 fell on an absolute basis while increasing on a percentage basis compared to the corresponding period of 2023. It was $17,700,000 compared to $18,700,000 in the same period last year. This reflects an operating margin of 14.1 percent for the quarter compared to 12.7% in the Q4 of 2022.

Speaker 1

On a constant currency basis, calculated based on average currency exchange rates for the 3 month period ended December 31, 2022, non GAAP operating income for the Q4 of 2023 would have decreased by 2.8% to 18,200,000 dollars for the quarter. Financial expenses. During the quarter, we had financial debt interest expenses of $1,500,000 related to our $81,000,000 financial debt compared to $700,000 of interest expenses recorded in the same period last year related to a total financial debt of $51,000,000 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 rate, which has been subject to higher interest rate 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 former shareholders in acquired entities as minority stakeholder. In addition to their managerial role in such entities, we are allocating a portion of our net income to those minority shareholders.

Speaker 1

Net income attributable to non controlling interest increased $1,500,000 compared to $1,600,000 for the same period last year. Our non GAAP net income for the 4th quarter decreased decreased by 24% to $11,600,000 or $0.24 per fully diluted share compared to $13,400,000 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 $535,100,000 down approximately 5.6 percent for $568,800,000 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.

Speaker 1

On a constant currency basis, calculated based on the average currency exchange rate for the 12 months ended December 31, 2022, revenues for 2023 would have decreased by approximately 1.6% to $557,900,000 compared to 2022, dollars 22,800,000 higher than our reported revenue figure for the year. Turning now to profitability. Despite the significant currency headwind and the problems with our U. S.-based revenues during the second half of twenty twenty three, we were nevertheless able to increase our gross margin for the year by 120 basis points to 29.6 percent of revenues or $158,400,000 compared to 28.4 percent in 2022 in which it was $160,800,000 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 $71,800,000 compared to $74,500,000 in the same period last year.

Speaker 1

This reflects an operating margin of 13.4% for the quarter compared to 13.1% in 2022. On a constant currency basis calculated based on average currency exchange rates for the 12 month ended December 31, 2022, non GAAP operating income for the year would have reached to $74,500,000 same as last year. Our non GAAP net income for the year decreased by 6.5 percent to $48,400,000 or $0.99 per fully diluted share compared to $51,700,000 or $105 per fully diluted share in 2022, which was a product of the reduction in our operating income and financial expenses resulting from increased level of debt and increased bank interest. Turning now to the balance sheet. As of December 31, 2023, our cash and cash equivalents and short term bank deposits amounted to approximately 107,000,000 dollars same as of September 30, 2023.

Speaker 1

Our total financial debt as of December 31, 2023 amounted to 81,000,000 compared to $88,000,000 as of the end of the previous quarter. Our cash flow from operating activities was $12,400,000 during the Q4 of 2023 compared to $12,100,000 in the same period of 2022. Our cash flow from operating activities for the year increased 29 percent to $77,900,000 compared to $60,000,000 excluding payments of deferred and contingent consideration related to acquisition 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 3rd quarter earnings call, as of the Q3, 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 1700 Israeli employees.

Speaker 1

We acknowledge that while short term completions 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 $540,000,000 $550,000,000 based on current currency exchange rate. This guidance for 2024 when measured against our annualized 2023, 4th quarter revenue on a go forward basis reflects an annual growth of 7.5 percent to 9.5 percent. 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 suppress our previous sites, thereby ensuring sustained growth and the continual enhancement of shareholders' value.

Speaker 1

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.

Operator

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

Speaker 2

Yes. 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?

Speaker 1

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 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 airport against Hamas. I think that's what drove our revenues significantly higher was first of all the fact that we are operating in strong sectors like the finance sector and the high-tech sector and of course the defense sector which because of the events in Israel had to accelerate project, deliverables and even increase the level of operation that we had with them prior to the happenings in Israel.

Speaker 1

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 significant 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 twenty twenty four.

Speaker 2

Got it. And how would you describe the environment in the U. S. Versus the last two quarters? Have you seen any change?

Speaker 2

I

Speaker 3

think we saw that things have come down a bit. So we don't face any more cuts. And so we're trying it's a bit we don't want to tend to sound optimistic, but we start to see new hirings. But yes, it's on a small scale. Therefore, we prefer to be conservative.

Operator

The next question is from Maggie Nolan of William Blair. Please go ahead.

Speaker 4

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?

Speaker 1

I think that's going to lead and again looking forward next year as we said in the mid term to return to our regular pace of 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 the operation is always if you look back for 3, 5, 7 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.

Speaker 1

S. Market, lowering our lower 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.

Speaker 4

Thank you. And with respect to your revenue guidance for the year, what are the foreign currency assumptions baked into that guidance?

Speaker 1

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 current exchange rate.

Speaker 4

And on a year over year basis, what is roughly the impact using the current level?

Speaker 1

Basically, the average in 2023 was around 3.69. The coin exchange rate is 3.65. That's so currently, there shouldn't be any significant difference except for Q4, where the average rate was around 3.8 and today we are at 3.65. So again, on the Israeli side of our operation, 40

Operator

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

Speaker 3

Yes. So thank you everyone for joining the call. We hope to bring good news in the near future. And thank

Speaker 1

you for joining us.

Operator

Thank you. This concludes the Magic Software Enterprises Ltd 2023 4th quarter results conference call. Thank you for your participation. You may go ahead and disconnect.

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Earnings Conference Call
Magic Software Enterprises Q4 2023
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