Magic Software Enterprises Q2 2023 Earnings Call Transcript

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Provided by Quartr
August 14, 2023

There are 6 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2023 Second Quarter Financial Results Conference Call. Magic's Q2 2023 earnings release was issued before the market opened this morning, and it has been posted on the company's website at www atmagicsoftware.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. Asaf Bernstein and MAGIC's CTO, Mr. Yuval Ravi. Before we start, I would like to remind everyone that this conference call may contain projections or other forward looking statements.

Operator

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 our Investor Relations section of the company website.

Operator

I will now turn the call over to Mr. Of Seth Bernstein, CFO of Magic Software. Please go ahead.

Speaker 1

Thank you, Yoni, and thank you, everyone, for joining us Today, I will report our Q2 2023 financial results. During the call today, I will review highlights from our Q2 results and provide an overview of our achievements. We appreciate your continued support and look forward to sharing our progress with you. Revenues in the Q2 of 2023 increased $137,600,000 up 0.4% from the Q2 of 2023 of 2022. The currency headwind on revenues is significant compared to the Q2 of last year.

Speaker 1

On a constant currency basis calculated based on average currency exchange rate For the 3 months ended June 30, 2022, revenues for the Q2 of 2023 would have increased by 4.4% to a record breaking 2nd quarter result of $143,000,000 Even when compared to the previous quarter of this On a constant currency basis, calculated based on average currency exchange rate for the 3 months ended March 31, 2023, Our revenues in Q2 2023 would have been $1,800,000 higher than the reported one, reaching $139,400,000 These results demonstrate the continued growing investments made by enterprises and organizations worldwide even during the current challenging macroeconomic climate Leverage their digital technologies and cloud based platforms, creating high demand for our innovative software solutions and services, which together with the outstanding execution by our teams led to another quarter of solid performance recorded across our businesses. 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, our DNA was 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 demand expertise, dedication and innovation to which we bring industry leading best practices, ensuring that our clients' cloud deployment meets the highest standard of performance, scalability, security and reliability. Our suite of managed cloud services, which include services such as mock as a service, SOC as a service, DevOp 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 competencies while leaving the management and optimization of the cloud environment to us. We converted our integration and application product to be fully cloud native.

Speaker 1

We created some new products like Workspace and we are now starting to provide those products as managed cloud services, allowing our new and existing customers to move their businesses to the SaaS model, while keeping their legacy systems and with minimal disturbance to their business. The global cloud services market continues to experience rapid growth with businesses of all sizes Recognizing the benefits of migrating to the cloud, the managed cloud services market in particular is projected to witness substantial expansion due to the increasing complexity of cloud environments and the need for specialized expertise. What sets Magic apart is our deep domain expertise, A customer centric approach and a proven track record of delivering successful cloud transformation. Our team of seasoned professionals is committed to understanding our clients' unique needs and tailoring our services to drive tangible business outcomes. Moving to our financials.

Speaker 1

In the Q2 of 2023, our revenues in North America amounted to 69 $4,200,000 4.1 percent and approximately $2,900,000 lower than Q2 of 2022 and $3,400,000 lower compared to Q1 of 2023, mainly due to cutbacks made by several clients in the U. S. And especially CVS Health, which decided to reduce expenses and put on hold IT investment decisions, resulting in a decrease of close 250 of our U. S. Specialists since the end of 2022, most of them around 150 specialists during the Q2 of 2023.

Speaker 1

Revenue for Malisa and Elio operations amounted to $51,700,000 up 1% compared to Q2 of 2022. The impact of the continued devaluation of the new Israeli shekel versus the U. S. Dollar was material over our Israeli market revenue. On a constant currency basis, calculated based on average currency exchange rate for the 3 months ended June 30, 2022, Revenues for the Q2 of 2022 of our Israeli operation would have increased by $5,400,000 to $57,100,000 reflecting a year over year growth of 11.1%.

Speaker 1

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, defense, finance and the public sector, which compensated for the current slowdown we are experiencing in North America. Despite Seeing some ongoing caution during recent months in the high-tech sector, we are still witnessing a healthy demand and maintaining a solid pipeline to deliver continued growth During 2023, as our customers increasingly engages as a preferred partner for innovative digital transformation initiative And as such, we continue to fortify our position as the leading software solution and an IT services global vendor. We have a well established track record of growth, profitability and high cash generation and the Magic team worldwide It's committed to executing our strategy to deliver growth and continue improving our shareholders' value. Moving to geographical North America accounted for 50% of total revenues, Israel 38% Europe 9% And APAC and the Earth of the World accounted for 3% of our 2nd quarter revenues. Turning now to profitability, despite the significant currency headwind, We were able to deliver growth in our gross profit as well as in gross margin as our non GAAP gross profit for the Q2 of 2023 reached $41,600,000 up approximately 9.3% compared to $38,200,000 in the same period last year.

Speaker 1

Our non GAAP gross margin for the Q2 of 2023 increased by 240 basis points or 27.9 percent to 30.3% in the Q2 of 2023. The breakdown of our revenue mix for the 6 March period of 2023 was approximately 18.4% related to our software solutions with a gross margin of approximately 63.1% And 81.6% related to our professional services with a gross margin of approximately 21.6%. While in the first half of twenty twenty two, approximately 80% of our revenues were attributable to our Software Solutions segment with a gross margin of approximately 64% and 82% related to our professional services with a gross margin of approximately 20%. The breakdown of our gross profit mix for the 6 months period of 2023 was approximately 40% related to our software solutions and 60% related to our professional services compared to 41% 59% in the same period last year. Our non GAAP operating income for the Q2 of 2023 increased by approximately 4% to $18,400,000 compared to $17,800,000 in the same period last year.

Speaker 1

This reflects an operating margin of 13.4% for the quarter compared to 13% in the Q2 of 2022. On a constant currency basis, calculated based on average currency exchange rate for the 3 month period ended June 30, 2022, non GAAP operating income for the Q2 would have increased by approximately 7% to a 2nd quarter record breaking result of $19,100,000 Financial expenses net. During the quarter, we had financial debt interest expenses of $1,200,000 resulted from $89,600,000 financial debt Compared to $400,000 recorded in the same period last year for a total financial debt of $56,500,000 As our overall debt continues to grow in 2023 and as the majority of our debt bears variable interest rate, We still expect interest expenses twice compared to 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 the managerial role in such entities, we are allocating a portion of our net income to those minority shareholders. Net income attributable to non controlling interest increased to $1,800,000 compared to $1,600,000 in the same period last year.

Speaker 1

Our non GAAP tax expenses this quarter totaled $2,900,000 compared to a tax expense of $3,900,000 in the Q2 of 2022. Our effective tax rate for the first half of twenty twenty three was approximately 17% compared to 20% recorded in the same period last year. Our non GAAP net income for the 2nd quarter increased 15.4 percent to $13,500,000 or $0.28 per fully diluted share compared to $11,700,000 or $0.24 per fully diluted share in the same period last year. Turning now to the balance sheet. As of June 30, 2023, cash and cash equivalent and short term bank deposit amounted to approximately $106,000,000 compared to $106,400,000 in the previous quarter.

Speaker 1

Our total financial debt as of June 30, 2023 amounted to $89,600,000 compared to $67,400,000 in the previous quarter. During the Q2, Magic paid shareholders $14,700,000 with respect to its 2022 second half semi annual dividend distribution as well as $12,300,000 towards settlement of liabilities related to acquisition, which we acquired in prior years. Our cash flow from operating activities reached $23,900,000 during the Q2 of 2023, compared to $5,600,000 in the same period last year. In our press release issued today, we announced that Fagic Board of Directors has The semiannual cash dividend in an amount of $0.327 per share or in the aggregate amount of approximately $16,100,000 reflecting approximately 75% of our net income for the first half of twenty twenty three. The dividend will be paid on September 13, 2020 to shareholders of record as of August 30, 2023.

Speaker 1

In closing, I would like to turn to our guidance for 2023. Our revenue guidance update considers the following two main factors. 1, the impact of foreign exchange headwinds And mainly the continued devaluation of the new Israeli shekel versus the U. S. Dollar and 2, the slowdown of our operations in North America market.

Speaker 1

With respect to the exchange rate turbulence, we continue witnessing a significant weakness of the new Israeli shekel versus the U. S. Dollar, which began during the second half of twenty twenty two and has been continuously deteriorating ever since. The impact on our yearly revenue guidance for the previous guidance reported in May amounts to approximately $6,000,000 With respect to the slowdown we have experienced during the first half of twenty twenty in the North American market and in particular the reduced level of our workforce At CVS Health, though we start seeing first signs of improvement, we are still below our original expectations And as such, decided to reduce the forecasted revenue level until the end of the year. The impact on our annual guidance amounts to approximately $9,000,000 As a result, we have updated our revenue guidance from a range of $585,000,000 to $593,000,000 To a new range of $570,000,000 to $580,000,000 We anticipate that Q3 will be higher than Q2 revenues by 3.5% to 4 In summary, we remain committed to executing our strategy, leveraging our strength and delivering sustainable growth and value for our shareholders.

Speaker 1

Our business model enables us to navigate the current macroeconomic environment with added stability. Today, over 85% of our revenue comes from existing clients, Giving us stability and highly visible source of cash from operations. Our confidence in the market's need for digital transformation and in our ability to address it remains high. We can confidently continue to execute our strategy to deliver growth and generate cash. I would like to thank our clients and our shareholders for their continued support and trust, and we look forward to deliver greater success throughout the remainder of 2023.

Speaker 1

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

Operator

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

Speaker 2

Hi, guys. Thanks for taking my questions. First off, could you give any color about what contributed to the margin expansion? Would that Have just derived from the reduction of the North American related employees or was something else Going into that, any color on that would be helpful.

Speaker 1

Yes. In major aspect, mainly the reduction of our operation with CVS, which carried much lower gross margins than our other professional service projects that we do. With CVS, because of the magnitude of overall relationship in our business, We have something between 10% to 12% gross margin. And as you can see, our average gross margin is around 28%, 28 point So once that went down, it impacted our gross margin for the quarter.

Speaker 2

Okay. And you mentioned seeing some signs of improvement. Can you give any color on that as it leads into the pipeline for maybe next year? And maybe if you could just comment on What kind of projects are you seeing being done now maybe in lieu of something else?

Speaker 3

Yes. Hi, this is Ivo. We see, again, the digital transformation and cloud movement to the cloud all over. Even in some places, we see CVS in the future going into more digital transformation. And this is what reassure us that We are on the right track as far as looking to provide the cloud transformation to our customers.

Speaker 1

In terms of our prospects, during the 1st 6 months of the year, we did see A significant reduction of new business coming from the U. S. In several sectors that we operate in, if it's in the telecom, of For the Healthcare, as I mentioned, but also for cloud consumption and from high-tech companies, by the end of The Q2 and let's say all through the month of July, we see clients Coming back, we see pipelines recuperate. So we believe that this is not something that only Represent July, but something that we feel is a window going back to Improvement rather than one thing thing.

Speaker 2

Great. Thanks. That's really helpful. That's it for me.

Operator

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

Speaker 2

Thank you. Can you talk

Speaker 4

a little bit about the kind of percentage of revenue coming from your managed cloud services versus other Services that you offer and how you expect that to be developing over time?

Speaker 1

First of all, I need to put out that if we look at the cloud consumption, for example, And today, we sell something around $60,000,000 in approximately $60,000,000 give or take In current cloud consumption, but we don't show it on a gross. We show it on the net, And this is under gross margin that can run from 4% around 4% or 5% or 5%. So despite the fact that we sell what we see as significant amount of revenues from cloud consumption services, this It's not something that is highly reflected on our top line. Nevertheless, it of course brings other type of Businesses and Services, as I mentioned, as a SOC as a Service,

Speaker 3

Nokia service, FinOps and all other managed services. Also, we can see that our I think more than 50% of our ongoing offering that are in the market are asking for managed cloud services, Regardless to the type of cloud services, but they want it as a managed cloud service and not as perpetual or not as on premise. So we see it more and more. I think it's hard to say the cut and the absolute numbers that are being here and there because there's a shift That we see in some places, but also increased. So from putting the line, it's hard at the moment for me at least.

Speaker 4

Got it. No, that's helpful.

Speaker 2

Thank you. And then on the demand side of things, can you talk a

Speaker 4

little bit about Now what level of these are cancellations? Is the spend that you expect will materialize In the future, at some point? And then what do you think it takes for your customers to get comfortable kind of loosening up their budgets and spending again?

Speaker 5

I think we need to differentiate here between the U. S. Market and The rest of the world. In the U. S, we saw that customers started to Squeeze their budget at the beginning of the year to end down dramatically towards mid second quarter.

Speaker 5

And now we start to see again that they start to hire again, but we prefer to be cautious here because we don't know where it goes. In the Israeli market, for example, nothing happened. It's like the market with all the mess in the country Business is rather good. But again, we prefer to be cautious because There is some kind of uncertainty, political uncertainty that affected at the beginning and Now it's like we see that the business are growing again. So this is where we stand.

Operator

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

Speaker 5

Yes. So thank you everyone for joining another call with Medics Software. We definitely I intend to bring you more good news in next quarters. Thank you very much.

Operator

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

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Key Takeaways

  • Magic reported Q2 2023 revenues of $137.6 million, up 0.4% year-over-year and a record +4.4% on a constant currency basis despite significant FX headwinds.
  • Non-GAAP gross profit rose 9.3% to $41.6 million and gross margin expanded 240 bps to 30.3%, while non-GAAP operating income grew 4% to $18.4 million (13.4% margin).
  • North America revenues declined ~4% as CVS Health cut IT spend, whereas Israeli operations grew 1% nominally and 11.1% on a constant currency basis, driven by healthcare, defense, finance and public sector clients.
  • Balance sheet highlights include $106 million in cash, $89.6 million in financial debt, strong operating cash flow of $23.9 million in Q2, and a semiannual dividend of $0.327 per share.
  • Full-year revenue guidance was lowered to $570–580 million (from $585–593 million) due to FX headwinds and North American softness, though Q3 is expected to climb 3.5–4% sequentially.
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Earnings Conference Call
Magic Software Enterprises Q2 2023
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