Magic Software Enterprises Ltd. (MGIC) CEO Guy Bernstein on Q1 2022 Results - Earnings Call Transcript

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Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q1 2022 Earnings Conference Call May 12, 2022 10:00 AM ET

Company Participants

Guy Bernstein - Chief Executive Officer

Asaf Berenstin - Chief Financial Officer

Yuval Lavi - Vice President, Technology and Innovation

Conference Call Participants

Tavy Rosner - Barclays

Operator

Welcome to Magic Software Enterprises 2022 First Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

With us on the line today are Magic’s CEO, Mr. Guy Bernstein; Magic’s CFO, Mr. Asaf Berenstin; and Magic VP of Technology and Innovation, Mr. Yuval Lavi. Magic 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.

Before we start, I would like to remind everyone that this conference 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 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’s Investor Relations section of the company’s website.

I will now turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

Asaf Berenstin

Thank you, operator and thank you everyone for joining us today as we report our first quarter 2022 financial results. During the call today, I will give you highlights from our first quarter results and provide an overview of our achievements.

Magic delivered its strongest start ever to the year with first quarter revenue increasing by 29% year-over-year to $138.7 million, exceeding market expectations. The global Magic team has successfully delivered on all fronts in Q1 across all our flagship geographies. The organic revenue growth was 20.4%, with a balance of 8.9%, resulting from the consolidation of acquired subsidiaries. This achievement delivered a 26% year-over-year increase in our non-GAAP operating income, amounting to $18.9 million with an operating margin of 13.6% compared to 13.9% operating margin for the full year of 2021.

Magic Software is a global company, operating across multiple markets and offering broad IT software services supported by its proprietary technology. Our strategy allows us to balance our growth, resources, investments and risk across regions and markets. Our solid execution in the first quarter validates our strategy of building a broad business portfolio, which provides the foundation for our sustained solid performance in growth as we continue supporting our customers through their digital transformation journey based on our long-term engagement cycle.

Moreover, we invest significant efforts in improving and enhancing our offering to help our clients develop a well-rounded approach of trust and safety as part of our broader customer experience strategy. We are witnessing a healthy demand and developing a growing pipeline to deliver continued growth in 2022 as our customers increasingly engage us as the preferred partner for digital transformation initiatives. As such, we continue increasing our resources despite fierce competition over talented IT workforce in order to further support existing and future transformation projects while carefully maintaining a balanced level of expenses.

We are extremely proud of the positive results we continue to demonstrate, particularly from our organic growth. With more than 3,700 talented employees spread globally compared to 3,100 in the respective period, we strongly believe that we have all the tools in place for sustained growth. We have a well-established track record of growth, profitability and high cash generation and the Magic team worldwide is committed to execute our strategy to deliver, allowing us to continue improving our shareholder’s value.

Moving to the financials and starting with the geographical breakdown of our revenues. During the third quarter, North America accounted for 51% of total revenues; Israel, 39%; Europe, 7%; and APAC and the rest of the world accounted for 3% of our first quarter revenues. Most of our growth in absolute numbers has traditionally came from North America and Israel, which continued to be our strongest territories. Our revenues in North America reached $73.6 million, up 37% compared to $53.7 million in the same period of the previous year, accounting for 64% of our growth in the first quarter. On a sequential basis, North America revenues, was up 3% from $71.5 million in Q4 2021. Revenue in Israel reached $51.8 million, up 26% compared to $41.2 million in the same period last year, accounting for 34% of our growth in the first quarter. On a sequential basis, Israel revenues was up modestly from $51.1 million in Q4 2021. Although on a constant currency basis, Israel’s sequential growth would have been 3%.

Turning now to profitability. Our non-GAAP gross profit for the first quarter of 2022 was $38.9 million, up approximately 23% compared to $31.7 million in the first quarter of last year. Our non-GAAP gross margin for the first quarter of 2022 decreased by 150 basis points from 29.6% in the first quarter of 2021 to 28.1% in the first quarter of 2022. The decrease in our gross margin is mainly attributable to the change of our revenue mix related to our software solutions compared to our professional services. The breakdown of our revenue mix for the first quarter of 2022 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 20%. While in Q1 of 2021, 23% of our revenues were attributable to our Software Solutions segment, with a gross margin of approximately 64% and 77% related to our professional services with a gross margin of approximately 20%.

The breakdown of our gross profit mix for the first 3 months of 2022 was approximately 44% related to our software solutions and 56% related to our professional services compared to 48% related to our software solutions and 52% related to our professional services in the same period last year. The increase in 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 Enable IT acquired in April 2021 to our Professional Service business segment.

Moving to operational costs. R&D expenses, on a non-GAAP basis in the first quarter of 2022, totaled $3.2 million compared to $3 million in the same period of last year as well as in the previous quarter. Our non-GAAP operating income for the first quarter of 2022 increased 26% to $18.9 million compared to $15 million in the same period last year. This reflects an operating margin of 13.6% for the quarter compared to 14% in the first quarter of 2021 and 13.9% for the whole year of 2021. Our non-GAAP tax expense for the first quarter totaled $3.6 million compared to a tax expense of $2.6 million in the first quarter of 2021. Our effective tax rate for the 3-month period of 2022 was approximately 20% compared to 18% recorded in 2021. We expect our effective tax rate in 2022 to be in the range of 20% to 21%. Our non-GAAP net income for the first quarter increased approximately 26% to $12.9 million or $0.26 per fully diluted share compared to $10.3 million or $0.21 per fully diluted share in the same period last year.

Turning now to the balance sheet. As of March 31, 2022, cash and cash equivalents, short and long-term bank deposits and marketable securities amounted to approximately $113.5 million compared to $96.6 million in the previous quarter. Our total financial debt as of March 31, 2022, amounted to $60 million compared to $37.2 million in the previous quarter. On April 7, 2022, in accordance with our dividend policy, we paid our shareholders a cash dividend of approximately $10.6 million or $0.216 per share for the second half of 2021. From a cash flow perspective, we generated $11.2 million from operating activities in the first quarter of 2022.

In closing, I would like to turn to our guidance for 2022. Given our current business momentum and growing pipeline and despite the expected headwind resulting mainly from the current devaluation of the new Israeli shekel and the euro versus the U.S. dollar, negatively impacting our prior annual revenue guidance by approximately $9 million or approximately 1.9% of our growth and the impact of the Jewish holiday season of Passover, which took place this year during April versus March in the prospective period last year. We are revising our 2022 annual revenue guidance to a new range of $540 million to $550 million from a previous range of $535 million to $545 million, reflecting annual growth rate of 12.4% to 13.5% compared to 2021.

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

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Maggie Nolan of William Blair. Please go ahead.

Unidentified Analyst

Hi, congrats on the quarter. This is Jesse on for Maggie. Can you talk a little bit more about what gave you confidence to increase full year guidance?

Asaf Berenstin

As I said, we – from basically end of last year, through now, we are seeing significant demand for our services. We are signing and increasing our – we are signing new projects and increasing our pipeline, you need to understand that over 80% of our ongoing business is basically depends on existing customers, which rely on our services based on very long engagement cycles that we have with them. So, that gives us a significant clarity of our future revenues.

Unidentified Analyst

Understood. And then my follow-up is on M&A. How does the pipeline look? And are there any specific functions you are looking to acquire?

Guy Bernstein

So, on the M&A side, I must say that the pipeline is not that great, meaning we do have some things, rather small companies. Until now, everything was rather expensive. I hope that with what’s going on in the market, we will see more reasonable deals. Of course, we always target first technological companies and then, of course, services companies that kind of complement our product and services. And as I explained before, most of the M&A that we do are coming from the business itself. It’s not like we are getting calls from bankers saying, hey, we have this company for you usually. It’s kind of businesses that we know, businesses that we are working with partners. So relatively, there are other small risk M&As.

Unidentified Analyst

That’s helpful. Thank you for taking my questions.

Guy Bernstein

Thank you.

Operator

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

Tavy Rosner

Yes. Thanks for taking my questions. I have two, please. The first one is, are you seeing the current microenvironment kind of weighing on investment decision? Any companies coming to you and say, we know we might delay the investment by like a quarter or two quarters? And I guess the second question is, what is the most successful segments you’re selling into these days? Is there anything in particular that’s standing out or it’s just across the board?

Guy Bernstein

So, as for the delays, I must say that for now, we don’t see any significant delays. If it’s a delay, it’s not due to the situation in the market. It’s mostly because the companies are – the teams that the companies are not ready yet or things like that, we – not due to the global situation in the market. We don’t see delays and…

Asaf Berenstin

The main sectors where we see the growth coming from is basically in all the – in all our main sectors that we are working for – that we are working with is the healthcare that is still strong and picking up, it’s the defense sector, it’s the financing sector that is also strong. Startups are also a big driver of our operations. In terms of – again, if you are asking what can the microeconomic situation impact as on the startup industries. But again, they are not such an important part of our operation.

Tavy Rosner

Great. Thanks for the color and congrats on the strong results.

Guy Bernstein

Thank you.

Operator

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

Guy Bernstein

Yes. So, thank you very much for joining another good conference call for us, and we hope to bring you more good news in the near future. Thank you.

Operator

Thank you. This concludes the Magic Software Enterprises Limited 2022 first quarter results conference call. Thank you for your participation. You may go ahead and disconnect.

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