Magic Software Enterprises Q3 2023 Earnings Call Transcript

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Provided by Quartr
November 14, 2023

There are 5 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2023 Third Quarter Financial Results Conference Call. Magic's Q3 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.

Operator

With us on the line today are Magic's CEO, Mr. Guy Bernstein Magic's CFO, Mr. Assaf Bernstein and Magic's CTO, Mr. Yuval Avi. Before we start, I would like to remind everyone that projections filings or other forward looking statements may be provided on this conference call.

Operator

The Safe Harbor provision provided in the press release issued today also applies to the contents 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.

Operator

I will now turn the call over to Mr. Asaf 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 Q3 2023 financial results. During the call today, I will review the highlights from our Q3 results and provide an overview of our outlook. Revenue in the Q3 of 2023 decreased to $129,500,000 down approximately 10% from the Q3 of 2022. As we already mentioned during our conference call for the Q2 results of operations, the effect of the core fluctuations on our revenues over the course of the year is significant compared to the corresponding quarters of last here. On a constant currency basis, calculated based on average currency exchange rates for the 3 months ended September 30, 2022, revenues for the Q3 of 2023 would have decreased by approximately 6% compared to the Q3 of 2022 to $135,300,000 $5,900,000 higher than our reported revenue figure for the quarter.

Speaker 1

As we described in the pre announcement of our Q3 results on November 8, the reduction in our Q3 revenues was caused primarily by 2 factors. 1, currency headwinds caused by significant deterioration of the new Israeli shekel relative to the U. S. Dollar in 2023, which has hurt our Israeli shekel denominated operation by $6,300,000 for the Q3 compared to the same period last year And 2, a substantial and unexpected decline in demand for our software services from several of our important U. S.-based customers carrying low gross margins, which without any advanced notification and due to internal reasons unrelated to our software services decided to immediately suspend are significant parts of their active time and material based projects.

Speaker 1

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 note a significant post third quarter event. The outbreak of the Israeli war against the terrorist organization Hamas, which among other things has concurrently led to the drafting fight and wish our employees while fighting and the entire Israeli armed forces success at eliminating the terrorist organization that planned conducted the brutal murder of 1400 Israeli civilians and continues to hold 240 Israel and foreign hostages. The absence of our Israeli employees who were drafted for active military service since the beginning of the war on October 7, Together with the decline in demand for our software services from several of our more important U. S.-based customers and the continued challenging macroeconomic environment of high interest rates, persistent inflation and reduced capital spending have caused us anticipates significantly lower revenues for the 4th quarter in the range of $115,000,000 to 125,000,000 We pre announced our Q3 results on November 8 immediately after the effect of all of the foregoing factors became clear to us And in order to present multiple updates to our investors, while the effect of such factors was being carefully analyzed by us.

Speaker 1

Once the effect of all of these factors was clear, we immediately updated our investors. I would highlight that we have provided a wider than normal range given that many of the factors are outside of our control. But that said, we have taken a very conservative approach and feel very comfortable with this guidance range. Despite all of those difficulties working against us, we continue to flow 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 offering are critical as customers continue to automate and digitize their systems and products.

Speaker 1

And while some of our customers are facing macro 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 team and our adherence to our cost structure enabled to maintain our profitability despite the lower revenues. In the Q3 of 2023, our non GAAP operating margin held strong at approximately 13.3% of our revenue, 10 basis points higher compared to the margin during the first half of twenty twenty three and twenty basis points higher compared to the corresponding period last year. This shows the inherent scalability and defensibility of our business model In our ability to maintain 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 as soon as the opportunity presents itself. 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.

Speaker 1

We similarly continue to see excellent execution by our teams. Setting aside the factors that slow us down that slow 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. Since the 1st 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 exceptional value to our comprehensive suite of managed cloud services.

Speaker 1

We have made it our mission to assist businesses in overcoming the challenges associated with migrating to the cloud and achieving true SaaS excellence. We recognize that the cloud is not just a 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 aspects of cloud operation, empowering our clients to focus on their core competence while leaving the management and optimization of the cloud environments to us. Our integration and application products are fully cloud native and we are now starting to provide those products and manage cloud services allowing our new and and existing customers to move their businesses to the SaaS model while keeping their legacy systems and with minimum disturbances to their business. The global cloud services market continues to experience rapid growth with businesses of all sizes recognizing the benefit of migrating to the cloud.

Speaker 1

The managed cloud service market in particular is projected to witness substantial expansion due to the increasing complexity of cloud environment and the need for specialized expertise. As of today, Magic has over 200 logos consuming its managed cloud services. What sets Magic apart is 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 we are well positioned to provide our customers with their optimal solutions tailored to their unique needs. Proceeding to address our Q3 financials, in the Q3 of 2023, our revenue in North America amounted to $58,500,000 approximately $19,200,000 or 25 percent lower than the Q3 of 2022 $11,000,000 or 15% lower compared to the Q2 of 2023, mainly due to additional CapEx made by several clients in the U.

Speaker 1

S. Among with some of our largest customers, we decided to reduce put on hold IT investment decision resulting in a decrease of close to 500 of our U. S. Specialists compared to the respective quarter last year. Revenue for my Israeli operation amounted to $54,000,000 up by 2% compared to 50 $3,100,000 reported on Q3 of 2022.

Speaker 1

The impact of continued devaluation of the new Israeli shekel versus the U. S. Dollar was a material factor in reducing our dollar reported Israeli market revenue. On a constant currency basis, revenues for the Q3 of 2023 of our Israeli operation would have increased by $7,200,000 year over year to 60.3 $1,000,000 reflecting a year over year growth of 13.6% 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 account to 25% of our revenue defense, which accounts for 10%, finance 20% and the public sector, which accounts for 5%, which allowed us to partially compensates for the current slowdown we experienced in North America.

Speaker 1

Turning now to profitability. Despite the significant currency headwind and the problems with our U. S.-based revenue in Q3, we were nevertheless able to increase our gross margin for the Q3 of 2023 by 130 basis points to 29.4 percent of revenues were $38,100,000 compared to 28.1 percent in the same corresponding quarter of 2022 in which it was $40,500,000 The breakdown of our revenue mix for the 1st 9 months 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 the 1st 9 months of 2022, approximately 17% of our revenues were attributable to our Software Solutions segment with a gross margin of approximately 64% 83% related to our professional services with a gross margin of approximately 20%. The breakdown of our gross profit mix for the 9 months period since the start of 2023 was approximately 41% related to our software solutions and 59% related to our professional services compared to 40% 60% in the same period last year. Our non GAAP operating income for the Q3 of 2023 fell on an absolute basis while remaining relatively the same on a percentage basis compared to the corresponding period of 2022.

Speaker 1

It was $17,200,000 compared to $18,900,000 in the same period last year. This reflects an operating margin of 13.3% for the quarter compared to 13.1% in the Q3 of 2022. On a constant currency basis calculated based on an average currency exchange rate for the 3 months period ended September 30, 2022, non GAAP operating income for the Q3 of 2023 would have decreased by 5% to 17,900,000 financial expenses. During the quarter, we had financial debt interest expenses of $1,700,000 related to our $87,000,000 financial debt compared to $600,000 of interest expenses recorded in the same quarter last year related to a total financial debt of $60,000,000 As our overall debt grew in 20 20 3 and as the majority of our debt bears variable interest rate, which has been subject to higher interest rates in 2023 compared to the same period last year, We expect interest expenses to continue to rise in the 4th quarter compared to the corresponding quarter of 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 stakeholders, In addition to their managerial role in such entities, we are allocating a portion of our net income to these minority shareholders.

Speaker 1

Net income attributable to non controlling interest increased to $2,000,000 compared to $1,500,000 for the same period last year. Our non GAAP net income for the 3rd quarter decreased by 24% or $10,400,000 or $0.21 per fully diluted share compared to $13,700,000 or $0.28 per fully diluted share in the same period last year, which was a product of the reduction in the operating income and increase in financial expenses resulting from the increased level of debt and the increase in bank interest rate. Turning now to the balance sheet. As of September 30, 2023, cash and cash equivalent and short term bank deposits amounted to approximately $107,000,000 compared to $106,000,000 as of June 20, 2023. Our total financial debt as of September 30, 2023 amounted $88,000,000 compared to $90,000,000 as of the end of the previous quarter.

Speaker 1

During the Q3 of 2023, Magic paid its shareholders a semiannual cash dividend of $0.327 per share or approximately $16,100,000 reflecting approximately 75% of our net income for the first half of twenty twenty three, which we paid on September 13, 2023 to shareholders of record as of August 30, 2023. We furthermore paid $3,000,000 in Q3 2023 towards payment of financial debt. Our cash flow from operating activities was $22,900,000 during the Q3 of 2023 compared to $21,900,000 in the same period of 2022. In closing, I would like to turn now to our guidance for the Q4 of 2023. As we stated in our earnings pre announcement issued on November 8, our updated revenue guidance for Q4 2020 estimate that our revenue will be in the range of $115,000,000 to $125,000,000 for that quarter.

Speaker 1

That reflects the confluence of adverse factors that I identified towards the start of this call. The deterioration of the new Israeli shekel against the U. S. Dollar, which carry relative low margins, the absence of a significant portion of our Israeli workforce, which has been called to duty in the Israeli war against Hamat, And last, the general challenging macroeconomic conditions which weigh against capital spending by our clients. In summary, we acknowledge that while Short term conditions are not ideal.

Speaker 1

We are nevertheless optimistic that in 2024, once the major part of the world is behind us and Arisa Eli customers return to full operation, they will resume to engage us to an increasing degree as a preferred partner for innovative continued to fortify our position as a leading software solutions and IT service global vendor. We have a well established track record of growth, ability and high cash generation and the Magic team worldwide is committed to executing our strategy to deliver growth and continue improving our 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 now turn the call over to the operator for questions.

Operator

Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. The first question is from Maggie Nolan of William Blair. Please go ahead.

Speaker 2

Hi. Good afternoon to you guys. This is Jesse on for Maggie. We hope everyone is safe in Israel, but Could you remind us of the makeup of your delivery in other countries and your ability to transfer work to other locations?

Speaker 1

If you heard my short brief, as I said, currently, except for the 200 people that are Currently being drafted, actively drafted. Basically, we have good work and good business relationships still going on with our clients, most of our clients are large financial institutions or customers working in the defense sector, which are all in the healthcare sector, which will not much influenced by the but what is going on now in Israel. The fact that we are losing 200 people Doing time and material work, of course, this is something that we can't compensate. And in most aspects, we can't necessarily Move to other locations.

Speaker 2

Understood. And then for my follow-up, is there anything incremental you can share about the cancellations? And Would you be able to elaborate on demand in your other sectors outside those cancellations?

Speaker 3

Yes. I think that what we've seen in North America, We updated at the end of last quarter that we saw some slowdown and we spoke to some of the big customers That were cutting some employees. Towards, At the end of this quarter, we saw a significant reduction in force by some of the customers. It was across the board, so I cannot identify a specific customer. Although we still work with all of them, Some of them decided to cut some of their projects while continuing with the project, they still continue with us.

Speaker 3

All in all, it was really unexpected and on top of the calls that we had with them before that. But we will make the relevant adjustments and will bring the business back to speed.

Speaker 2

Makes sense. Thanks for taking our questions.

Speaker 3

Thank you.

Operator

The next question is from Chris Rimer of Barclays. Please go ahead.

Speaker 4

Yes. Hi. Thanks for taking my questions. Last quarter, I believe You did note the decrease in specialists, particularly for CVS Health. Now when you mentioned these issues today, has that customer maintained the same level or have you seen further decline at that customer?

Speaker 4

And just also how can we look at margins given the issues that you've brought up earlier in your comments?

Speaker 3

Okay. So as for the specific customer, I think the main hit Well, let's say the significant heat came from this customer. While we talked to this customer last time, We understood that they are going for some kind of cut offs and later on they decided to go deeper. In terms of the margin, I don't think it's going to affect the margins percentage wise. It may even get we may even get better margins because Of the rebate policies of most of them, so we can improve the margins on the percentage side.

Speaker 3

In absolute numbers, we will probably feel a small Heat on the numbers, but again, I think we are doing whatever is needed in order to overcome this.

Speaker 4

Got it. And regarding the managed cloud services vertical, can you give us an idea of What percentage of your business is there or how should we look at that progressing going forward?

Speaker 3

When you talk about percentage of the business from the total business or from the total?

Speaker 1

I will comment on that. First of all, we need to understand that in terms of cloud services, we separated between cloud consumption On the cloud consumption side, we are currently running at the run rate of around $60,000,000 gross in terms of cloud consumption, we are working mainly with and with AWS and we are now establishing a much deeper relationship also with the GCP. So we expect these revenues to continue to rise. Those amounts which I mentioned, we don't present them at gross, we present them Net, so we of course offset the cost that we pay to those vendors for such service. So it has a much, much minimum impact over the total revenues that The services that you see that we provide and as you see in other reported, we experienced around 13% average growth in real terms in the Israeli market, significant portion of it comes from projects that we provide to 200 different logos today on managed services on different aspects of managed services on cloud.

Operator

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

Speaker 3

Yes. So I know that this quarter was not the best quarter for us. We take the time and I believe that within The next two quarters, we will bring the business back to speed. Of course, there are some unknowns with the war that is going on now in Israel. But assuming this is the status that we are facing now and it will not get worse, Then I believe that in the next two quarters, we'll bring the business up to speed to growth again.

Speaker 3

And Just to remind you, as our investors, for the last probably 14 years, we've taking the business from quarter by quarter and every time we succeeded in bringing good news to our investors and we hope that we'll bring that sooner rather than later To you guys, thank you for joining and thank you for the patience.

Operator

Thank you. This concludes the Magic Software Enterprises Ltd 2023 Third Quarter Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

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Magic Software Enterprises Q3 2023
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