Magic Software Enterprises - Q2 2024

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to Magic Software Enterprises 2024 Q2 Financial Results Conference Call. Magic's Q2 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. At this time, all participants are in listen-only mode. A brief question and answer session will follow the formal presentation. 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 sections 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 (CFO)

Thank you, operator, and thank you everyone for joining us today as we report our Q2 2024 financial results. During the call today, I will give you highlights for our Q2 results and provide an overview of our outlook. Revenues in the Q2 of 2024 decreased to $136.3 million, down approximately 1% from the Q2 of 2023. On a constant currency basis, calculated based on the average currency exchange rates for the three months ended June 30, 2023, revenues for the Q2 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., acquired at the beginning of the Q2. 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 healthcare, 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 Q2 and first half revenues compared to last year's results is primarily driven by two 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 six-month period, which, along with the devaluation of other foreign currencies, reduced our reported revenues by $1.9 million for the Q2 and by $4.5 million for the six-month period. And more important, the substantial and unexpected decline in demand for our 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 material-based projects, particularly in the face of softer demand and budget constraints.

That said, over the past 6-9 months, client sentiment in the US has remained stable, with no significant changes, either positive or negative. While we have not yet been seen material market improvement, we believe that an improving US economy could serve as a catalyst for growth in our US operation. Although our full year guidance does not currently account for any macroeconomic improvement, 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 sales of our world-class suite of products and in providing related services. Our AI, low-code, no-code and service offerings are critical as customers continue to automate and digitize their systems and products.

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 Q2 held strong at approximately 13.4% of our revenues, same as in the Q2 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 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 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 aspects 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 Q2 financial results. In the Q2 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 demonstrates a 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 revenues. Turning now to profitability. Our gross margin for the Q2 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 semi-annual 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 breakdown of our revenue mix for the six-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 six-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 Q2 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 Q2 of 2023. On a constant currency basis, calculated based on average currency exchange rates for the three-month period ended June 30, 2023, non-GAAP operating income for the Q2 of 2024 would have reached $18.4 million, same as it was in the Q2 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 exchanges, 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 attributed to non-controlling interests. 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 these minority shareholders.

Non-GAAP net income attributable to non-controlling interests slightly increased to $2 million, compared to $1.8 million for the same period last year. Our non-GAAP net income for the Q2 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 quarter, 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 deposit 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 six-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-$550 million. I will now turn the call over to the operator for questions.

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. If you have a question, please press star one. If you wish to cancel your request, please press star two. If you are using speaker equipment, kindly lift the handset before pressing the numbers. Your questions will be pulled by the order that they are received. Please stand by while we pull for your questions. The first question is from Maggie Nolan of William Blair. Please go ahead.

Maggie Nolan (Research Analyst)

Hi, thank you. 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, you know, demand for your services have evolved since you saw the weakness last quarter. Am I right in, you know, perceiving that you have a little bit of increased optimism around North American customers in particular?

Guy Bernstein (CEO)

So basically, in Israel and in Europe, especially in Israel, we see a phenomenon where we continue to grow. The demand is very strong, although what's happening in Israel. In the States, right now, we see it's 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, you know, a year and a half ago.

Maggie Nolan (Research Analyst)

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

Guy Bernstein (CEO)

I think if we live, let's say, in a stable environment, I would probably... I think 14% is achievable. But, you know, 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 (CFO)

So just to emphasize, 14, between 13.5% and 14% is for the operating margin, and for the gross margin, it would be something between the 29% and 30%.

Maggie Nolan (Research Analyst)

Okay, that's helpful. Thank you very much.

Operator (participant)

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

Chris Reimer (Equity Research Analyst)

Hi, thanks for taking my questions. I have two, 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 revenues mix, or is it due to the acquisition that you mentioned earlier? And then following on that, if you could just touch on the, the acquired business, a little more in detail.

Asaf Berenstin (CFO)

So in terms of the margins, eventually this quarter, we had less billable days in the Israeli market. In the Q1, we had around 65 billable days. In the Q2, we had 59 billable days because of the Passover holiday season. As Israel is 43%, same as in, same as the U.S., sector, that we work, you know, that influences our gross margin and take it, take it down a bit. We managed to still, you know, maintain a solid margin, as you mentioned, because of the sales of our software licenses, which basically are 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, you know, it's a company that provide software services, staff augmentation, work mainly from headquartered 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 are also working with SMBs, they were less impacted by the economic macroeconomic situation today in the U.S., which hinders mainly, you know, large organizations that we work with.

With them, we are positive that, and we are seeing that they manage to maintain their profit and grow from one year to another. So for us, it's another good addition for operations in North America. As we normally do from, you know, one year to another, we look for this kind of operation, this kind of businesses, and we hope to acquire them.

Chris Reimer (Equity Research Analyst)

Great, thanks. That's really helpful. That's it for me.

Operator (participant)

If there are any additional questions, please press star one. If you wish to cancel your request, please press star two. Please stand by while we pull for more questions. There are no further questions at this time. Mr. Bernstein, would you like to make your concluding statement?

Guy Bernstein (CEO)

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

Operator (participant)

Thank you. This concludes Magic Software Enterprises Limited 2024 Q2 results conference call. Thank you for your participation. You may now go ahead and disconnect.