Magic Software Enterprises Ltd.'s (MGIC) CEO Guy Bernstein on Q4 2020 Results - Earnings Call Transcript

Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q4 2020 Earnings Conference Call March 8, 2021 10:00 AM ET

Company Participants

Asaf Berenstin - Chief Financial Officer

Guy Bernstein - Chief Executive Officer

Yuval Lavi - Vice President, Technology & Innovation

Conference Call Participants

Ted Starck-King - William Blair

Tavy Rosner - Barclays

Kevin Dede - H.C. Wainwright

Operator

Welcome to Magic Software Enterprises 2020 Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

Magic's quarterly earnings release was issued before the market opened this morning and it has been posted on the company's website at www.magicsoftware.com. Representing Magic Software today are Magic’s CEO, Mr. Guy Bernstein; Magic’s CFO, Mr. Asaf Berenstin; and Magic’s VP of Technology and Innovation, Mr. Yuval Lavi.

Before we start, I would like to remind everyone that this conference call may contain projections or other forward looking statements. 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 Magic Software Investor Relations section of the company website.

I would now like to turn over the call to Mr. Asaf Bernstein, CFO of Magic Software. Please go ahead.

Asaf Berenstin

Thank you, operator, and thank you, everyone, for joining us today as we hold our fourth quarter 2020 financial results. As we said in the past, our business is benefiting from global trends that are driving our growth. This includes first and foremost, the demand for wide range of top technologies, methodologies and services for the SMB enterprise digital transformation device for services, as organization continue to migrate from legacy systems to more than flexible on-premise or cloud-based solution, as well as the need for meeting customers' expectations for digital and more personalized experience.

On that note, Magic’s Q4 was an outstanding finish to a strong and challenging year. Despite COVID-19, we closed for the first time during the fourth quarter the $100 million mark in quarterly revenue coming in at the $105 million, 15% higher than last year. This achievement was further supported by the 33% increase in operating income to a record of $15.3 million.

For the full-year, revenue increased by 14% to $371 million, and we delivered operating margin of 14.2% compared to $326 million in revenues and 13.5% operating margin in 2019. These record results were the outcome of our focus on strategic execution. Although during 2020, we signed over 200 new logos across all our business lines and territories, 1/3 related to our software solution and the remaining to our professional services.

On the M&A front, Magic has demonstrated in the past solid track record of acquisitions that have accelerated top line and bottom line growth. We have proven our ability to successfully integrate acquisitions and improve the operational performance of the combined entities.

Through our acquisition strategy, we have expanded the offerings for our customers and increased our global footprint. During the second-half of 2020, we completed the acquisition of Stockell Information System Inc. and [Optimate Inc.,] [ph] both U.S.-based companies, which specialize in IT staffing and recruiting to expand our presence in the U.S. market and diversified our client portfolio.

Both Stockell and Optimate Inc. that consists of 230 IT consultants and their customer base that includes blue chip companies like Bayer, Norfolk Southern, and Edward Jones investments contribute to our efforts to fulfil our commitment to our clients to serve as a one stop shop for a full set of solutions and continue our expansion.

We continue with our effort to find potential companies that fit our strategy and our valuation range. We continue looking for small-to-mid-sized companies with revenues in the range of $10 million to $50 million, which will follow our strategy, geographic expansion, complementary solutions and customer base.

Turning now to our fourth quarter and annual business performance, I will now review our non-GAAP results followed by comments on the balance sheet, cash flow and end with our outlook for 2021.

Our fourth quarter revenues totaled $105 million compared to $91 million for the fourth quarter last year and $95 million in the previous quarter, reflecting 15% and 10% growth respectively. Our fourth quarter revenues were mainly fueled by increased demand for professional services in North America and in Israel, and especially in the healthcare and the defense sector.

Looking at the geographical breakdown of our revenues during the fourth quarter, North America accounted for 49% of total revenues, Israel 39%, Europe 7% and APAC and the rest of the world accounted for 5% of our annual revenue. Most of our growth in 2020 in absolute number was the visionary for North America and Israel, which continued to be our focus territory.

North America accounted for 46% of our growth for the 12 months, while Israel accounted for 52% of our growth. And on a quarterly basis, North America accounted for 61% of our growth in the fourth quarter compared to the respective period last year, and Israel accounted for 38% of our growth.

Our revenues in North America for the 12-month period grew 13% year-over-year and our revenues in Israel for the 12-month period grew 16% year-over-year on a constant currency basis.

Turning now to profitability. Our non-GAAP gross profit for the fourth quarter of 2020 was $32.5 million, up approximately 11% compared to $29.4 million in the fourth quarter of last year.

Our non-GAAP gross margin for the fourth quarter of 2020 decreased from 32.3% in the fourth quarter of last year to 31.1%. Our non-GAAP gross margin for the 12-month period of 2020 decreased to 31.3% compared to 33.1% in the same period of last year. The decrease in our gross margin is mainly attributable to the change of our revenue mix related to our software solutions versus our professional services.

The background of our revenue mix for the 12-month period of 2020 was approximately 22% related to our software solution and 78% related to our professional services, compared to 26% related to our software and 74% related to our professional services in 2019 as a whole. The increase in the percentage of our professional services is due to the continued strong demand for our professional experts, driving our professional service revenue stream and the addition of Stockell and Optimate to our professional services business segments.

The breakdown of our gross profit mix for the 12-month period of 2020 was approximately 47% related to our software solution and 53% related to our professional services, compared to 50% related to our software and 50% related to our professional services in 2019 as a whole.

Moving to operational costs, R&D expenses on a non-GAAP basis in the fourth quarter of 2020 totaled $3.1 million compared to $2.9 million in the same quarter of last year and $3.1 million in the previous quarter.

Our non-GAAP operating income for the fourth quarter increased 34% to $15 million compared to $11 million in the same period last year. This reflects an operating margin of 14.6% for this quarter, compared to 12.5% in the fourth quarter of 2019 and 14.9% in the third quarter of 2020.

Our non-GAAP operating income for the year increased 20% to $53 million, compared to $44 million in the same period last year. This reflects an operating margin of 14.2% for the year compared to 13.5% for 2019. The growth in our operating income reflects 70% organic growth and 30% from the M&A.

Our non-GAAP tax expenses this quarter totaled $2 million compared to a tax expense of $2.9 million in the fourth quarter of 2019. Our effective tax rate for the 12-month period of 2020 and – end of 2019 was 17% and 19%, respectively. The decrease in our effective tax rate in 2020 resulted mainly from $1.2 million reversal of tax provision following completion of tax assessment conducted in the regular course of our business. We expect our effective tax rate in 2021 to be in the range of 19% to 20%.

Our non-GAAP net income for the fourth quarter increased 63% to $10.3 million or $0.21 per fully diluted share compared to $6.3 million or $0.13 per fully diluted share in the same period last year. Our non-GAAP net income for the year increased 32% to $37.3 million or $0.76 per fully diluted share compared to $28.2 million or $0.58 per fully diluted share in 2019.

Turning now to the balance sheet. As of December 31, 2020 cash and cash equivalents short and long term bank deposits and marketable securities amounted to approximately $92 million, an increase of $7 million from the previous quarter. Our total financial debt as of December 31, 2020 amounted to $25 million, compared to $29 million in the previous quarter.

From a cash flow perspective, we generated $11 million from operating activities in the fourth quarter, and $52.3 million during the 12 months period of 2020. I would like to turn out to our guidance for 2021.

In 2021, we anticipated revenue in the range of between $420 million to $430 million, reflecting annual growth of 13% to 16%. This reflects 9% to 12% organic growth with the contribution of the M&A conducted during 2020 adding additional 4%

In our press release issued today, we announced that Magic Software Enterprise Board of Directors has declared the semi-annual cash dividend in the amount of $0.21 per share, and the aggregate amount of approximately $10.2 million for the second half of 2020. Together with a dividend distributed for the first half of 2020, these payments reflect approximately 75% of our net income, and 50% of our non-GAAP net income for the 12-month period of 2020.

In summary, this was a strong challenging and overhaul exceptional year of execution on many fronts, and we want to congratulate the Magic Global team for their outstanding work in 2020 especially during these uncertain times introduced by the COVID-19 global pandemic demonstrating the rapid and professional adaptation to the challenges of COVID-19.

The results we deliver show that our strategy is working and that we -- and by focusing on our investment to deliver profitable growth, which can significantly enhance shareholder value. With thousands of customers, approximately 3000 talented employees spread globally in a broad portfolio of solutions supported by proprietary software, we have all the tools in place to help our clients reach major milestones in their digital transformation projects and for continued growth. With that I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

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

Ted Starck-King

Hi, Asaf, this is Ted Starck-King on for Maggie. Thanks for taking our questions. So I guess, first of all, a strong, strong revenue performance in the fourth quarter. Can you maybe dig into where your outperformance in the fourth quarter came from relative to your expectations last quarter?

Asaf Berenstin

I think that we saw very strong demand from the healthcare, defense and banking sectors. This is something that worked for us for the entire year. But in Q4, especially the defense and the healthcare sector contribute to significantly or mainly to the growth. I can tell you, for example, that during the fourth quarter, we recruited out of 200 people that grew organically in the company, 100 people were recruited during the fourth quarter. So you don't even see the entire impact on our revenues for the year for the healthcare sector. So this was - so the defense and the healthcare were the main contributors to the fourth quarter improvement.

Ted Starck-King

Thanks. That’s very helpful. In terms of your expectations for the revenue mix for 2021, what are your expectations for the next between software and services? And then how does that compare to kind of your medium-term expectations?

Asaf Berenstin

I think that as we can see, the main contribution of the technology does not come from the, say, the change in revenues versus what we have on the professional services because the professional services is significantly higher than the sale of technologies. We sell today around our technology segment around $90 million. The remaining through these $370 million that we report comes from the professional service. So the main impact of our technology comes on the bottom line.

In that aspect, if we - and this is something that is very difficult to say because I can't say that we won't continue to do acquisition in the professional service segment. We have some leads. All of them basically are on the software professional - on the professional service side of the business.

So on the mixture between software and services, I believe that we will continue to see the software, a percentage of our business declining on another 1% or 2% for next year versus the additional revenues that we gain on the professional service side of the business.

On the other hand, we managed to consistently generate something around 65% to 67% gross profit on our technology. So even a small improvement on the software side of the business contributed significantly to the bottom line.

Ted Starck-King

Very, very helpful. Thank you. Can you share some of your insights into kind of the headcount additions? It sounded like you mentioned earlier that the fourth quarter, you had a strong recruiting quarter. Can you talk about the 2021 kind of your expectations for headcount additions, utilization, and pricing?

Asaf Berenstin

Let's summarize first 2020. In 2020, we grew around 400 people in our headcount, half of it came from the two acquisitions that I mentioned of Stockell and Optimate, 230 IT specialists. Another 200 came from organic recruitment, net organic growth of our overall headcount. If we expect 9% to 11% organic growth next year, this is since we are working on the professional service side mostly, then it would be supported by an increase in our headcount.

Ted Starck-King

Okay, thanks. And then last question from me. Can you talk about just the margin expectations for 2021 and kind of the cadence of that margin throughout the year? Thank you.

Asaf Berenstin

I’ll touch it in two aspects, one aspect, I think that over the - even if I look over the last few years, we managed to maintain the gross margins on the side of the technology and of the sides of the - and on the side of the professional services, we are at around 22%, 23% gross profit on - gross margin on the professional side, and we are – and around, as I said, 65% or 67% on the on the technology side. And this is something that we managed to keep over the years, it becomes very challenging.

I can tell you that, for example, in 2020 and opposed to many other - perhaps many other companies, we tried not to reduce salaries, and even where we needed to increase salaries for IT specialists because we knew that, this is a period that show period that we need to overcome. And we want to maintain all of our workforce for the second-half of the what was 2020 and, of course for 2021. And we believe that we will see the fruits for that. It becomes then, on the other hand, very difficult to roll over increase that we have in salaries to the clients. As you know, some of them are also facing market difficulties and this COVID thing is not over yet.

So altogether, I believe that for the next year, we will still manage to continue and maintain the level of margins that we see today. And I even expect an improvement on our operating margin from 2021 - from 2020 to 2021, as we did in 2020 versus 2019, so another 0.5%.

Ted Starck-King

All right, very good. Thanks for taking my questions.

Operator

The next question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner

Hi, thanks for taking my question. And perhaps you mentioned that during 2020, you sign about 200 new logos. Were there particular verticals that we're interested in your product? I remember last quarter you mentioned healthcare. If you were to break it down to 200 in different categories, where would they be?

Asaf Berenstin

We’re working with again with SMB. I think I can say that it doesn't necessarily change from the percentage that we normally see Magic as a whole. So we maintain around 20% of our business from the finance sector or something the same on the same range in the defense sector, around 15% in the healthcare sector. So, I believe that we pretty much go to the same location of these verticals.

Tavy Rosner

Right, that's helpful. And then when you look at - you just mentioned margins in the previous questions, do you take into account the resumption of your travel expenses towards the second-half of the year? Or is that already part of your operating assumption?

Asaf Berenstin

I think that altogether, the COVID, the impact on our cost was not was not that significant, something, something about 1.5 million in saying, in cost cutting, put aside the salaries, which were already increased and already reflected in our in our numbers. So I don't think this has a significant impact over our expectations for next year. We are generating $53 million in operating profit. We are growing normally the same in the same range, in our revenues in our bottom line; even we have some exponential growth in or better growth in the operating in the operating profit. So, so I don't think that this, this would have a significant impact on our bottom line, even if it will increase back in the second half of 2021.

Tavy Rosner

Great, that's helpful. Thank you very much, and congrats on these numbers.

Operator

The next question is from Kevin Dede of H.C. Wainwright. Please go ahead.

Kevin Dede

Good afternoon gentlemen. Thanks very much for taking my call. I, I'm curious about a couple things, maybe we can take a step back and, and sort of look at overall demand by geography, obviously, strong and Israel. And U.S. as you said, with healthcare, defense, your typical verticals, but I'm wondering if we could look a little bit at Europe, and maybe some of the others, APAC just give us a sense of what you're seeing there, and how much there, it might be a little different.

Asaf Berenstin

Again Europe, today is around 7%, of our of our revenues. There wasn't a significant a significant change, or even if there is a significant change, it doesn't have a significant impact. On our way on our business we seem to, to once you have a significant customer base, in industry region in the U.S. and in Israel, most as you can see for the last years, or for many years that most of our growth come from our existing community, something around 85% of our revenues, are generated from a continuous projects, new projects that we managed to get from our existing customers. So this is why once we have established in the U.S. and in Israel, this is the main growth engines that we produce today. Europe is, again, is pretty small. So I think they were like a bit a bit flat on the on the revenue this year.

Kevin Dede

Okay, fair enough. Thanks. So I think you mentioned, I guess the focus with acquisitions and building customers and technology, and I noticed that obviously, right, you spoke to two acquisitions, they seem to be on the professional services side. If we were, sort of looking on the, on the grand scheme, maybe the five year plan is the company's focus really to build out more professional services and become sort of less reliant on developing new software? How would you characterize the overall strategy?

Guy Bernstein

Hi, Kevin. Most of our acquisitions are most of the opportunities are coming from within the business. We don't usually get opportunities from investment banking firms. And therefore, most of the opportunities are kind of related to our business therefore, they are in nature more conservative and more safe to go on one hand. On the other hand, I must say that the prices are picking up so we get to see less and less attractive deals on the software side, rather than on the professional services side. We need to probably invest more in it and see how to go through this one and get some more software businesses as well.

Kevin Dede

Okay, so can we talk a little bit about that too, Guy. And the PowWow integration evolves on the call, maybe, if I remember correctly; you were hoping to have that pretty well integrated through the first half of this year. And I was wondering if you could touch on that, and, and maybe some of the customer response that you're getting?

Yuval Lavi

Yes, we are running basically on schedule. We are going to release our release candidate on May. And we are already sharing this information with customers around the world. And there is excitement. Again, it's there, they haven't had the chance to play with it. And they only see it they obviously on some kind of a small level online, but we see the fire is picking up around customers that are looking to actually move their legacy system all the way down to the to the web and to the mobile. I have tomorrow meeting with the insurance company here in Israel regarding taking their obligation into a mobile deployment. And everything is around that. And we're getting a big technology push by the combination of combining power platform indoor studio.

Kevin Dede

Okay, do you think that sort of changes the way people look at Magic software? I mean, given now that it's still rights, it's more hands on consulting. Do you think? I mean, do you think it opens more business development opportunities for you having that type of functionality built in?

Yuval Lavi

I believe, it does. Again, what will be the effect this year or next year, I still, it's hard to say, we have the good. The benefits of being 35 years old technology company that are still around live and kicking in with customers that are having their code base since 25 years ago. Okay, so this is strength. On the other hand, we have conservative customers that it's hard for them to actually jump into new technologies and new frontiers. So we're doing it a bit in a in a careful way, we cannot just run forward and forget our existing customer, because this is our biggest strength I think. On the other hand, we need to push our customers to adopt new technology, which is sometimes you know some of them are excited about it. And some of them, it's hard for them to move to new technologies in a way.

Kevin Dede

Right, understand, if it works, don't change it. The thing that's really interesting, you've always said, you're, it seems to me that you're flourishing, I think you guys are doing what seems to me to be a great job. Right? I mean, it's it was really, as I sort of made the point, it's really difficult operating environment for the past 12 months. And your numbers seem to show that it had basically not much of a problem compared to a lot of other companies. So I guess I'm wondering if you think the fact that you're doing well might change the perception of some of the larger companies that, they might be concerned that Magic Software is up and coming. Now, granted you've been there a long time, but now you're on $4 million run rate, you're not so small, right? Over the past seven years, as Asaf knows I've been following you. It's been a big change.

Guy Bernstein

Yes. But we're still rather small, especially when you're talking about the U.S. market. I think the big difference is that although our number a big portion of our numbers is coming from the professional services side, I doubt that I'm probably sure that most of our customers do not see us as a professional services shop on one hand. On the other hand, I think the big barrier that we faced during the years was the fact that the big names are used to work with bigger size and we were targeting all the time mostly the SME market, so we have to be seen yes, I think it's an opportunity. But history show that, we can we can fight better in places that there is a limit of either money or time.

Kevin Dede

Right. So Guy, do you think you’ll be able to talk a little bit more about how you're going to market, the new software capabilities maybe on March quarter call? Or do you think it might not be until the June quarter call that you'll talk about how…

Guy Bernstein

We as always we start, we usually start with our base community. After we get some feedback from them, we start to expand to new clients. So we need to say that, if there is a good exception by then, then we will be able to talk about it.

Kevin Dede

Okay. But as it is you don't, you don't really see that you're going to change the way you go to market.

Guy Bernstein

We're trying to kind of go to the, let's say tier out call, then probably tier three, tier two. But if we're talking about long sales cycles, and until now, we are doing way better with the SME market.

Kevin Dede

Understood, understood. So the -- it's still a majority on the technology side, it's still the focus is still integration, right? I mean, obviously you've all talked about pushing model more to the cloud and the mobile, which is something you guys have been working on for years. But with a low code solution, it just seems to me that it would facilitate that for a lot of companies. And is there going to be a scale issue? I mean, if you're able to push up to address larger customers, would that strap resources and personnel that maybe you'd have to change given a bigger deal or longer sales cycle?

Guy Bernstein

I know I don't think so. I think we can manage it. Every now and then we do face like a big customer that we need to, to serve. And until now it was not a problem. Of course, if it will be like a phenomena and suddenly we'll have like tens of customers like blue chip names will have to reorganize, and but it's a good problem [ph].

Kevin Dede

Okay. Do you think there's going to be a change in given the change in administration here in the U.S? Do you think there's going to be a change in emphasis on defense work? Or maybe collaboration between Israel in the United States?

Guy Bernstein

Good question. Right now I must say that I'm more concerned about what's going on in the state that was going on here with the election.

Kevin Dede

Okay. Fair enough. Thank you, gentlemen. Always a pleasure to talk to you. Congratulations on a really great quarter, and a really good year considering the circumstances.

Guy Bernstein

Thanks.

Operator

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

Guy Bernstein

So thank you all for joining the call this quarter. And we sure hope to bring you some more good news in the next one. Thank you.

Operator

Thank you. This concludes the Magic Software Enterprises fourth quarter and 2020 result conference call. Thank you for your participation. You may go ahead and disconnect.