Magic Software Enterprises - Earnings Call - Q2 2025

Transcript

Speaker 4

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises 2025 second quarter financial results conference call. Magic's second quarter 2025 earnings release was issued before the market opening 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's CEO, Mr. Guy Bernstein, Magic's CFO, Mr. Asaf Berenstin, 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, and the safe harbor provision provided in the press release issued today also applies to the content of this call.

Magic has expressly disclaimed an obligation to update or revise any of these forward-looking statements, whether because of future events, new information, a trend in its view, or expectation, or otherwise. Also, during the course of today's call, management will refer to non-GAAP financial measures. Our expedition schedule showing GAAP and various 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 over the call to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead. Asaf, please go ahead.

Speaker 0

Thank you, operator, and thank you, everyone, for joining us today as we report our second quarter 2025 financial results. During the call today, I will review highlights from our second quarter results and provide an overview of our outlook. Revenue in the second quarter of 2025 increased to a quarterly all-time record of $161.6 million, up approximately 11.3% from the second quarter of 2024, and sequential growth of 2.8%. This quarter showcased solid execution, with Israel delivering a year-over-year double-digit growth of 18.8%, with more than 90% organic, primarily resulting from strong demand for our cloud services, DevOps services, and AI solutions, along with continued strong demand for our services in the defense sector. Our North American operations delivered strong performance this quarter, with revenue increasing approximately 6.5% year-over-year and 6% on a sequential basis.

In the U.S., results for the first half of 2025 reflected approximately 9% year-over-year revenue growth, driven by agreements executed in late 2024 and early 2025. We are beginning to see first signs of improvement in the U.S. market, reinforcing our positive momentum and positioning us for continued growth through the second half of the year. We remain steadfast in our global commitment and confident in our ability to drive continued growth through sales of our world-class product suite and delivery of high-value services. Leveraging our AI, low-code, no-code cloud-based platform and managed services, we are well-positioned to meet the accelerating demand for automation, digitization, and innovative software solutions. Our teams continue to execute with excellence, and our customers increasingly recognize the unique value we deliver, engaging us as a preferred partner for transformative digital initiatives.

This trend, combined with exciting opportunities across cloud technology and AI, reinforces our positive momentum, positioning us for a strong second half of the year. At Magic Software Enterprises, we are redefining the way organizations unlock the full potential of generative AI. As AI continues to reshape industries and everybody's lives, we are therefore transforming our internal operations, reimagining our product, and delivering next-generation services that drive measurable business impact. Today, we manage over 270 projects spanning across more than 20 industries, have expanded our expert team from over 30 to over 50 specialists, and offer comprehensive end-to-end solutions for successful GenAI adoption. From proof of concept to large-scale deployment, our customers enjoy a remarkable 70% success rate, nearly six times higher than the industry average of 12%.

Supported by more than 100 AI-focused events and over 10 strategic alliances with global leaders such as AWS, Microsoft Azure, and Google Cloud, we empower organizations in finance, healthcare, government, defense, and manufacturing to accelerate innovation, enhance productivity, and secure their competitive advantage in the AI era. With an average of three major AI developments announced weekly, we ensure our clients gain the benefits of the latest breakthroughs while keeping their strategies aligned with core business objectives. Backed by deep expertise and proven success, we see unprecedented opportunities to further expand and elevate our offerings. Proceeding to address our second quarter's geographic revenue breakdown. In the second quarter of 2025, our revenues in North America increased by 6.5%, from $58.4 million to $62.2 million. Revenue from our Israel operations totaled $68.7 million, an increase of 18.8% compared to $57.8 million in the same period last year.

On a constant quarterly basis, revenues grew by 13.5%. This performance underscores our strength in the region and reaffirms our long-term strategic focus on macro, stable, and technology-driven sectors. Revenues from our Israel operations accounted for 47% of our overall quarterly revenues. Turning to profitability, our non-GAAP gross margin for the second quarter of 2025 was 28.7% of revenue, amounting to $43.6 million compared to 29.4% or $40.1 million in the corresponding quarter of 2024. The year-over-year change in gross margin primarily reflects the composition of our revenue mix and the timing of renewals of our term-based software agreements. In the current fiscal year, the majority of these renewals are scheduled for the fourth quarter, with a smaller portion in the third quarter compared to the first and second quarters of the prior year.

Sequentially, our gross margin improved by 20 basis points, rising from 28.5% in the first quarter of 2025 to 28.7% in the second quarter. This improvement came despite the timing of the Passover holiday, which reduced second quarter billable days by approximately four and a half days compared to the first quarter. That reduction was equivalent to about 7% of time and material billable capacity in our Israel operations. The breakdown of our revenue mix for the second quarter of 2025 was approximately 17% related to our software solutions, with a gross margin of approximately 65%, and 83% related to our professional services, with a gross margin of approximately 21%. Compared to 18% related to our software solutions, with a gross margin of approximately 64%, and 82% related to our professional services, with a gross margin of approximately 22% in 2024 as a whole.

Our non-GAAP operating income for the second quarter of 2025 increased by 1.9% to $18.6 million compared to $18.2 million in the same period last year. During the second quarter, we had financial expenses of $700,000 compared to $1.2 million. The decrease in our financial expenses was mainly attributed to the continued decrease of our overall financial debts during 2024 and in the first half of 2025, for an average debt of $72 million during the second quarter of 2024 to $63 million during the second quarter of 2025. The balance of our financial debts as of June 30, 2025, amounts to approximately $70 million. 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 role in such entities, we are allocating a portion of net income to these minority shareholders.

Non-GAAP net income attributable to non-controlling interests decreased to $1.8 million compared to $2 million for the same period last year. Our non-GAAP net income attributable to shareholders for the second quarter increased by 8.7% to $12.7 million or $0.26 per fully diluted share, compared to $11.7 million or $0.24 per fully diluted share. Turning to the balance sheet, as of June 30, 2025, cash on cash equivalents and short-term bank deposits amounted to approximately $90 million compared to $112.8 million as of December 31, 2024. Our total financial debt as of June 30, 2025, amounted to approximately $70 million compared to $60 million as of December 31, 2024. On January 8, 2025, and on May 7, 2025, in accordance with our dividend distribution policy, we paid our shareholders cash dividends in the aggregate of approximately $27.6 million or $0.562 per share for the first and second half of 2024.

In addition, today, in accordance with our dividend distribution policy, our holders and hedge funds declared the semiannual cash dividends in an amount of $0.296 per share and in an aggregate amount of approximately $14.5 million, reflecting approximately 75% of our distributable profit for the first half of 2025. The dividend is payable on October 22, 2025, to all of the company's shareholders of record at the close of trading on NASDAQ Global Select Market on October 6, 2025. Cash flow from operating activities for the first half of 2025 amounted to $21.2 million, compared to $41.4 million in the corresponding period of 2024. For the 12-month period ended June 30, 2025, cash flow from operating activities totaled $64.6 million, compared to $67.7 million recorded in the respective period.

The decline in our first half cash flow from operating activities primarily reflects our increased investment in working capital to support our revenue growth trajectories. This is particularly evident in our record-setting top-line performance, with second-quarter revenues reaching an all-time high. These dynamics do not reflect a deterioration in our underlying performance. On the contrary, both operating income and net income increased compared to the same period last year. We expect cash conversions to normalize over the coming quarter. Turning to our guidance for 2025, we continue to observe healthy demands across our markets and are building a strong and growing pipeline that supports our expectations for sustained growth throughout the year. Accordingly, we revised our full-year 2025 revenue guidance, increasing the previous estimate of $593 million to $603 million to a revised range of $600 million to $610 million, based on current currency exchanges.

This updated guidance reflects the sustained operational momentum and favorable outlook for the remaining part of the year, representing an anticipated annual revenue growth rate of approximately 8.6% to 10.4% as compared to the prior fiscal year. In conclusion, I would like to reiterate the announcement made in March regarding the signing of a memorandum of understanding to enter into negotiations for the contemplated merger of Magic Software Enterprises into Matrix IT. This proposed transaction represents a significant inflection point in our corporate journey, one that holds the potential to be transformative for both organizations. The contemplated merger is expected to combine the strengths of two well-established technology leaders, creating a more diversified and resilient global IT service provider. The combined entity would possess enhanced capabilities to serve a broader range of customers across geographies and industries, sponsor accelerated innovation, and deliver sustainable long-term value to shareholders.

We continue advancing through the execution phase of the transaction and anticipate presenting the transaction for shareholders' endorsement in the fourth quarter of 2025. I will now turn the call over to the operator for questions.

Speaker 4

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 leave the handset before pressing the numbers. Your questions will be called in the order they're received. Please stand by while we pull for your questions. The first question is from Crystal Anna of Battles. Please go ahead.

Speaker 2

Hi. Congratulations on the strong results, and thanks for taking my question. Can you give us any color on customer behavior in the U.S. and perhaps to what degree, if any, you're seeing a recovery in IT spend in that region?

Speaker 0

Overall, it varies, of course, between the different operations that we have in the U.S., but with the major clients that we hold, we see increased demand. We need to remember that for, pretty much, almost a year, we saw a stagnant level of demand. Now, from the first quarter to the second quarter, and on our basis on our expectations for the remainder of the year, we see some expected recuperation in the demand for our services.

Speaker 2

Got it. Can you talk about some of the drivers that are impacting margins? How do you see these drivers evolving towards the end of the year, through the year-end?

Speaker 0

As I mentioned, mainly, we were impacted by the timing of the recognition of, or the spending of, our term license software, which last year mainly occurred during the first half of the year. This year, it is much concentrated on the first renewal terms, which are much concentrated on the fourth quarter of the year, with a small portion in Q3. This is on one hand. On the second hand, and more primarily, is the mix of our revenues. Basically, we see a significant increase in revenues from our projects and service operations. These operations, as I mentioned, carry a gross margin of around 21% versus our technology operations that carry the 64% to 65% gross margin. This quarter, for the second quarter and then for the first half of 2025, we saw the entire increase in gross profit coming from the professional service side of the business.

We expect for that to improve in the second half towards the software, which will improve the margins that you currently see and will level them on an annual basis at around 29%.

Speaker 2

Got it. Thanks. That's very helpful. If I could just ask one more around cloud, how would you describe the progress of customers transitioning to cloud services now, let's say, versus last year?

Speaker 0

Unless Yuval Lavi answers that?

Speaker 1

Yuval.

Speaker 3

I can take it, of course. We see more and more adoption of cloud from all around. New customers are jumping directly into the cloud, and the legacy customers, even in our Japanese territories, are starting to address and adopt the cloud solution and the cloud offering. As you know, we are a traditional business, and we have some legacy customers, but we're starting to see more and more move towards the cloud. We're looking forward to a bigger cloud adoption.

Speaker 2

Got it. Thanks. That's it for me.

Speaker 4

The next question is from Margaret Marie Niesen Nolan of William Blair & Company L.L.C. Please go ahead.

Speaker 5

Hi. Thank you. I'm hoping you could give us a little more commentary on how the pipeline is building, maybe the size and types of deals that you're seeing from customers.

Speaker 0

I think that the significant driver, just giving back on the prior question, is coming from cloud and AI. We see, as I mentioned, we have hundreds of projects that are in the mix. We managed to convert those projects, in a higher, in a much higher rate than industry standard. Those projects which also serve for cloud services. We managed to increase our position in that aspect, not only in the Israeli market, not only in the Israeli defense sector, but in many sectors, including the U.S. and also recently also in Canada and the U.K. This is one of the significant drivers that we see today in the business.

Speaker 3

The GenAI opportunities are definitely on the side of land and expand. We see a lot of landing, as you hear, 270 and more projects. This project is not ending. We keep on expanding. This is just the nature of what GenAI is doing to all of us in the market.

Speaker 5

Understood. Can you comment a little on the strategy behind the acquisition that was done in July and the contribution to the financials for this year? Thank you.

Speaker 0

We didn't acquire any company in July.

Speaker 5

A small manufacturing company?

Speaker 0

Actually, it's a very small operation. It's something at around $2.5 million in terms of turnover. It's a kind of a consultancy firm that we work with them as partners, and we acquire them in order to push forward our business.

Speaker 3

Custom AI.

Speaker 0

Custom AI operation in the U.S.

Speaker 5

Got it. Okay, thank you for taking my questions.

Speaker 4

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

Speaker 0

Thank you, everybody, for joining us for the call today. We hope to continue in giving you good news on our upcoming call.

Speaker 4

Thank you. This concludes the Magic Software Enterprises 2025 second quarter results conference call. Thank you for your participation. You may go ahead and disconnect.