Magic Software Enterprises Ltd.

Magic Software Enterprises Ltd.

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Information Technology Services

Magic Software Enterprises Ltd. (MGIC) Q2 2020 Earnings Call Transcript

Published at 2020-08-13 17:00:00
Operator
Welcome to Magic Software Enterprises 2020 Second 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. With us on the line 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. Magic’s quarterly earnings releases release was issued before the market opened this morning, and it has been posted on the company's Web site at www.magicsoftware.com. Before we start, I'd 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, 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 Web site. I will now like to turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.
Asaf Berenstin
Thank you, Joni, and thank you, everyone for joining us today as we report our second quarter 2020 financial results. Our second quarter results demonstrate our ability to deliver our software solutions and services for existing customers and closing new deals alongside our continued solid execution of our priorities of top line growth despite the continued global impact of the COVID-19 business disruption. Revenues grew by 12% year-over-year to $86.5 million in the quarter, with sales mainly coming from expansions of our business in North America and in Israel. Overall, COVID-19 had only small impact over our first and second quarter results as we prioritized performance, while adjusting our approach to operation. We continue to work closely with our large customer base, supporting them in their transition to the new working format and addressing the challenges they face. As market continue to adapt to the new normal, we see that the current business disruption related to the pandemic increased the sense of urgency for enterprises to migrate their legacy platform to enhance their competitive advantage by offering more digital solutions, while improving their operations efficiency. This alone is driving future opportunities for Magic Software as our business is benefiting from these global trends that are driving our growth. This includes most and foremost, the demand for the wide range of top technologies, methodologies, and services of the SMB digital transformation demand for services as organizations continue to migrate from legacy systems to modern, flexible on premise or cloud based solutions, as well as the need for meeting customer's expectations for digital and more personalized experience. Today, most of our deliverables to our existing customers continue as planned and we did not see a significant impact on our revenue streams from existing customers. Although, some prospects are taking longer to close as enterprises put new agreements on hold until there is less uncertainty from COVID-19. From Magic's point of view, our direct customer relations, as well as our trusted advisor approach, has been a beneficial aspect of our business model, especially in this challenging business environment as we help customers address the new and unique challenges to COVID-19. In return, this helps us secure our repeating revenues while increasing sales with our existing customer base, delivering additional services to enable our customer growth and success. Our priority remains executing on our growth strategy. For the remainder of 2020, I am pleased to say that deliverables to our existing customers remain on track. We will continue to grow where we have already landed and leverage our investment. We continue to see the growth in sales to our existing customers, which moves the viability of our position as a one stop shop for the SMB market with enhanced products and services. While there continues to be near term uncertainty for COVID-19, we remain focused on execution. Our teams are more focused on developing remote client relations and digital marketing tools to address the restricted travel and lack of face to face events. We have accelerated the online engagement model and have been very active with webinars and the remote user groups to replace the face to face session. Overall, we see that the action we have taken provided us the necessary flexibility and operating efficiency within the common circumstances. Solid demand for offerings with high repeating revenue and a solid balance sheet position us for success in the challenging environment. We continue to seek business growth organically and with M&A, while we seek further opportunities to increase operating efficiencies and improve margin. We are confident that as the global economy recovers, Magic Software will emerge stronger and well positioned for continued growth. Turning now to our second quarter 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 the remaining of 2020. Revenue in the second quarter of 2020 increased by 12% to $86.5 million compared to $77.1 million in the second quarter of 2019. Since the second half of 2019, we have experienced continued decline in revenue in the telecom industry. As a result, our second quarter results reflect a year-over-year decrease of $6.6 million in our revenues and a decrease of $1.7 million in our operating income. Excluding the decline in the telecom industry, our revenue grew by 24% year-over-year, 17% with respect to the acquisition of NetEffects, which was concluded on July 1, 2019 and 7% organic growth. Looking at the geographical breakdown over revenues during the second quarter, North America accounted for 49% of total revenues, Israel 38%, Europe 8% and APAC and the rest of the world accounted for 5% of our second quarter revenues. Most of our growth in absolute number was traditionally from North America and Israel, which continued to be our strongest territory. North America accounted for 51% of our growth in the second quarter and Israel accounted for 46%. Turning now to profitability. Our non-GAAP gross profit for the second quarter of 2020 was $26.5 million, up approximately 2% compared to $25.9 million in the second quarter of last year. The breakdown of our revenue mix for the six months 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 breakdown of our gross profit mix for the six months period of 2020 was approximately 46% related to software solution and 54% related to our professional services compared to 50% related to our software and 50% related to our professional services in 2019 as a whole. R&D expenses on a non-GAAP basis in the second quarter of 2020 totaled $2.8 million compared to $3.2 million in the same quarter of last year and $3 million in the previous quarter. The decrease in our R&D expense is related mainly to shift of development resources from Israel to India, and cost cutting measurements taken with respect to the COVID-19 business disruption. SG&A expenses on a non-GAAP basis in the second quarter of 2020 totaled $11.4 million compared to $11.4 million in the same quarter of last year and $12.3 million in the previous quarter. The decrease in our SG&A expenses versus the first quarter of 2020 is attributable to cost cutting measurement taken with respect to the COVID-19 business disruption. Our non-GAAP operating income for the second quarter of 2020 increased 14% to $12.2 million compared to $10.7 million in the same period last year. This reflects an operating margin of 14.1% for this quarter compared to 13.9% in the second quarter of 2019 and 12.9% in the first quarter of 2020. Excluding the decline in the telecom industry amounting to $1.7 million versus second quarter of 2019, our operating Income grew by 31% year-over-year, 50% mainly with respect to the acquisition of NetEffects, which was concluded on July 1, 2019 and 50% organically. Our non-GAAP tax expenses this quarter totaled $2.3 million compared to a tax expense of $2 million in the second quarter of 2019. Our effective tax rate for the six months period of 2020 was 20% compared to 19% recorded in 2019 as a whole. We expect our effective tax rate in 2020 to be in the range of 20% to 21%. Our non-GAAP net income for the second quarter is 14% to $8.1 million or $0.17 per fully diluted share compared to $7.1 million or $0.14 per fully diluted share in the same period last year. Excluding the impact of devaluation of the US dollar versus the new Israeli shekel during the second quarter of 2020, our financial income, net income would have increased 25% year-over-year to $8.9 million or $0.18 per fully diluted share. Turning now to the balance sheet. As of June 30, 2020, cash and cash equivalents, short and long term bank deposits and marketed securities, amounted to approximately $92 million compared to $89 million in the previous quarter. Our total financial debt as of June 30, 2020 amounted to $25.3 million compared to $20 million in the previous quarter. From a cash flow perspective, we generated $15 million from operating activities in the second quarter, which were offset mostly by $3.9 million related to dividend distribution to shareholder with respect to the second half of 2019, $4.4 million related to dividend distribution to non-controlling interest and $4.3 million related to M&A activities, mainly towards the acquisition of non-controlling interest. In our press release issued today, we announced that Magic Software Enterprise Board of Directors has declared a semiannual cash dividend in the amount of $0.175 per share and in the aggregate amount of approximately $8.6 million for the first half of 2020, reflecting approximately 75% of our net income and 30% of our cash flow from operating activities for the first half of 2020 and in accordance with our dividend policy. In closing, I would like to turn now to our guidance for 2020. The global economy experienced significant disruption from COVID-19, and we have managed the pandemic’s effect for both our employees and our customers worldwide. That said, our business model has shown its resilience in this challenging environment. From an operational perspective, we are a software company, which fortunately allowed us to remotely work from home or from client side. As a result, we have very high visibility of our revenue stream from existing customers. These facts will give us confidence for the remainder of the year, and we are reiterating our 2020 full year revenue guidance, which we expect to be in the range of $350 million to $360 million on a constant currency basis, reflecting an annual growth rate of 7% to 11% year-over-year. With that, I will now turn the call over to the operator for questions.
Operator
Thank you. Ladies and gentlemen. At this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.
Tavy Rosner
Hi, everyone. Thanks for taking my questions. I have a couple. First, you mentioned the strong demand you're seeing, driven by COVID-19, pushing companies to turn into more digital and throughout the transformation project. So with that in mind, I'm wondering why you’re reiterating guidance and not being a bit more constructive. Is that because you are being conservative in this environment, or because perhaps the project will take more time to kind of develop and turn into additional revenue?
Guy Bernstein
Yes, definitely. We’re being more conservative because of this all unknown situation. We see a lot of things going on. At the same time, we do see companies that are -- especially the young companies that are struggling to raise money. And therefore, we want to be in a position that if we surprise, we surprise for the good and not for the bad.
Tavy Rosner
Okay, that's helpful. And then you guys talked about the telecom market in your prepared remarks. Can you elaborate of what's going on there and what are your expectations for the second half?
Asaf Berenstin
In 2019, I can tell you that we experienced a very good start for the year, kind of in conjunction with the merger between Sprint and T-Mobile. I think that most of the carriers pretty much put on side their strong investment on the 5G generation. And with that, we also experienced a decline of our work, of our support that we provided to such companies. This is something that’s following the approval of the merger in 2020, started to release but it happened starting, I would say the -- close to the end of the second quarter and we expect an improvement of that. But if I take the first half of 2020 versus the first half of 2019, as you saw, there was a significant decline of around $6.6 million in our revenues quarter-over-quarter and amounted to $1.7 million loss of operating profit, which we managed to compensate with other projects that we have. But still for us year over year we expected to be at better place. I can tell you that once there is a turnaround of that market, we are ready to monetize on that as well.
Tavy Rosner
Okay, that's very helpful. And then perhaps the last one for me. COVID has put a lot of restriction on traveling and this is a place where you save money. And you know you talked about your digital capacity to kind of promote to clients and so on. And I guess I'm wondering looking beyond COVID and the current environment are there any cost savings that you guys can maintain that would kind of help your margins structurally?
Guy Bernstein
Yes, this is definitely what we intend to do. There is always a question of people who like to travel, they will always try to travel but definitely, we will be more strict on this one.
Asaf Berenstin
I can tell you that another thing that's worked for our benefit is that until today there was always a pressure on salary, we have lots of people, you know, in the professional service side of the business. And at the moment based on the economic environment, so there is no much pressure, you know, now as it was in the past to increase salaries. So this is something that should work on one side in our favor. On the other, you still have clients pushing on discount or run rates. So I think that overall this kind of supposed to support our growth and not reduce it.
Operator
The next question is from Kevin Dede of H.C. W. Please go ahead.
Kevin Dede
Thanks for taking my questions. Congrats on the great expense management. I was wondering if you could talk a little bit to your S&G costs this half, please.
Asaf Berenstin
So basically, we managed to save on the SG&A. We saved something around $1.1 million, $1.2 million compared to, if you look versus the first quarter. A significant part of that savings relates to kind of the current situation, not something that necessarily would last for the months to come. I would assume that we can keep approximately 50% or 40% of that cost cutting also for the future. But we have people on unpaid leave. We have some salary deduction. We have travel constraints. All of that are not necessarily going to continue as we progress on the year, but around 40% of that I believe that we will manage to maintain. I think that over the years, if you look back you can see that Magic always -- at least Magic asset management, always knew how to adjust our cost level versus the level of our operation. And this is something that was done for many years as I am with the company.
Kevin Dede
Can you talk to your head count at the end of the June quarter and what your expectations might be given prevailing circumstances?
Asaf Berenstin
Headcount didn't change much where we are at around 2,600 employees. I can tell you that today we have something around 150 open positions that we are trying to fill up, something let’s say that 70% of that is in the US, 30% are in Israel. So with that, we feel pretty confident with our ability to continue the momentum that we are in for the first half.
Guy Bernstein
The mass majority is billable people we’re looking for.
Kevin Dede
Okay. Listen, the overarching trend appears to be that professional services are becoming a greater and greater share of revenue. And I was wondering if you could kind of talk to why you think that's happening. Is the software development side of your business just less attractive to customers, or just finding greater demand on outsource people at your clients. Maybe just some insight on that overarching trend, please?
Guy Bernstein
Okay. So I’ll divide into this -- your question into two. One part is that every now and then we have renewal of -- or a new sale of software piece. And apparently this last quarter, it was less than the comparable quarter. And therefore, you see some decline in the software but it will probably change next quarter and the one after it. Other than that, when we look at the acquisition pipe then definitely we see more service oriented companies than software oriented companies. And you know, as a result, we did the last transaction. It was a -- it is a service based company and therefore, it affects the ratios between services and software.
Kevin Dede
Okay. Thanks. Can you -- I guess can you extend that and talk to what you see going forward in M&A? I mean, you guys have a ton of cash still. I know you've been very, very careful about picking and choosing. And I know all your investors appreciate that. I was just wondering if you’re thinking about becoming more aggressive, because I mean other companies are clearly not going to be in the same financial strength that you are, and they might be willing to negotiate more closely. Could you speak to that a little [Multiple Speakers]…
Guy Bernstein
We definitely look for such companies. For now we don't see yet a decline in prices, multiples. And all companies are still looking for rather high multiples, look at the capital markets, companies are raising money like if it was paper. So we don't see a pressure on companies that want to be sold, to sell their operation. Still, we have quite a nice spike. We progressed with what we have. And apparently the fact that we've been conservative is helping for the business, meaning we do quite safe acquisitions. I don't see even one acquisition that I can treat it as a bad influence on the business.
Kevin Dede
Okay. Do you foreseen maybe getting deals done over the remainder of this year or early next?
Guy Bernstein
Definitely…
Kevin Dede
…while before the COVID thing sort of gets resolved.
Guy Bernstein
We do have two companies in the pipe, like advanced situation. Hopefully, it will be closed.
Kevin Dede
Okay. Can you speak a little bit to the R&D activities? I noticed costs there were down. And I'm kind of wondering, number one, what are your clients asking for and what is your R&D development focus?
Guy Bernstein
R&D development is focusing, again, and kind of taking the wave of the low code back wind that we have. So going more and more kind of smart editor, Weebly, Wix, ease of development all around that and lot of cloud enabled -- I mean, cloud with us for the last 10 years or more, but really becoming more and more cloud native for their tools and environment of application.
Kevin Dede
Any insight on the cost, the cost side of that, it just seems…
Asaf Berenstin
I'll tell you, the headcount didn't change. It even grew. So most of the cost cutting happened because we shifted between 2019 and 2020 some of our R&D efforts from Israel to India. So that takes off the cost on one end. And on the other end, we also during the Corona time had some people that were utilizing the vacation days or were on some kind of unpaid vacation. So this is something that contribute to the reduction of the cost, just for the second…
Kevin Dede
So you kind of expect things to bounce back to more historical norms in the third quarter?
Asaf Berenstin
Yeah, something around the $3 million.
Operator
The next question is from Asaf Barel of Oppenheimer. Please go ahead.
Asaf Barel
Hey guys, congrats on a really nice quarter, great execution. On the professional services side of the business, any specific verticals you guys want to highlight as kind of having offset the telco decline? And then number two, any further comment you guys would want to give on the dividend? Thanks.
Asaf Berenstin
In terms of the sector that we managed to compensate with, it's the basically the finances sector where we are very strong in, the health care. We had some improvement on the cybersecurity companies utilizing people. We have 40, 50 people that are working around the cybersecurity. And we found people are trying -- that companies are trying to secure, better their technological infrastructure. That was the main, let's say, sectors that we managed to compensate with. On the dividend side, I think that there's no much to say. This is -- we are keeping -- we're pretty much keeping with our dividend policy. We took the second half where we distributed only 50% of our distributable profit just because back at the -- during April, May, there was more unclear, let’s say, site and now we are -- we feel that we are back on track. We have $91 million, $92 million on our cash. The company is generating $15 million per quarter from operating cash flow, leverage is low.
Asaf Barel
Just on -- so kind of on a go forward basis. We know that the mix it’s favoring professional services increasingly and we really see it clearly in the gross margins. I mean, where do you guys see the gross margin on a normalized basis? Is it closer to the 30.5-ish [than 1-ish], or is it closer to 32? I know it depends on where growth goes depending on the segment. But just any commentary there?
Asaf Berenstin
Its closer to the 32.
Operator
[Operator Instructions] The next question is from Maggie Nolan of William Blair. Please go ahead. Ted Starck-King: This is Ted on for Maggie. So I think in the press release and you mentioned it in your prepared remarks, you said you're gaining traction with some new and existing clients. Can you add some color around the new logo additions during the quarter? And then also in your prepared remarks, you talked about prospects taking longer to kind of ramp up. Can you talk about kind of the pace of project ramp ups in the second quarter and in July and August? Thank you.
Asaf Berenstin
I don't think that mentioning new logos and I'll tell you why, it’s something that we feel that we give you any more color about the business. First of all, 80% of the business is pretty much relying on our existing community, on one hand. And on the other hand, we don't have -- if I look at the fifth largest account that we have in the group, it doesn't account for more than 2% of our revenues. So every -- I can tell you that we are winning something around 80 to 100 new clients every quarter, and just something that build up the pie. This is something that can go to 100K or 200K or 500K, depends on the deal. So this quarter, we had Santa Clara, for example, that acquired our low code development platform with a deal of around $200,000, three year contract to develop low code business application and let's say, numerous examples like that. In terms of the improvement on the professional services side, then I think that we are just being on the -- or riding on the wave of the good sectors that we are in. As we said, people are trying to be more digitalized and they need to make sure that they are connected and allowing their customers to be connected more than they used to because of the COVID-19 or encouraged by the COVID-19. And we are riding those ways on the financial sector. We are riding those waves on the healthcare sector with CVS, or with the two largest healthcare providers in Israel. Defense sector is also we’re pushing hard and was even -- I can tell you the Israeli market was one of the sectors that helped prevail the COVID-19 disruption here the Israeli market. So we’re feeling pretty much benefited from that.
Operator
The next question is from Maggie Nolan of William Blair. Please go ahead.
Maggie Nolan
I dropped out there for a second. Could you clarify some of the numbers you mentioned earlier in the call? So you said excluding telecom, you grew 24% year over year and 17% excluding NetEffects and 8% organic. Did I hear that right?
Asaf Berenstin
Yes. I said that 17% was due to the acquisition of NetEffects, because we didn't consolidate NetEffects’ results during the first half of 2019. And in 2020, we consolidated during the full period. So 17% of the growth came from that and 7% came from the organic activity if I exclude the decline in the telecom sector.
Maggie Nolan
And then looking towards the back half of the year. Is there any seasonality that we should consider this year, and how would that compare to 2019?
Asaf Berenstin
We do expect the second half to be much better than the first half, basically due to the COVID impact over the first half, if something doesn't change dramatically. And basically when you look at our performance over the years, the second half was always better than the first half of every year.
Maggie Nolan
And then just related, I guess, to the holiday season this year between Q3 and Q4. Any comments there?
Asaf Berenstin
No. Not something special. We have the Jewish holiday season during April. Q3 is kind of thhe full, basically a full quarter that we have on September -- again, the new year, holiday season here in Israel. But this is -- and last year it happened on the fourth quarter. So there would be a shift between that but this is something that happens every other year.
Maggie Nolan
And then last question from me. Can you talk about the health of the CVS relationship and where you stand with that? Thank you.
Asaf Berenstin
Basically, I can tell you that business are good. We are improving our operations with CVS. We have more consultants working on the job for them. We are growing the business versus 2019. We are happy for the business that we are getting from CVS. And we are happy to support their growth and expansion as well.
Operator
There are no further questions at this time. Mr. Bernstein, would you like to make your concluding statement?
Guy Bernstein
So, thank you very much, everyone for joining our call today. And we definitely hope to bring you some news in the near future. Thank you.
Operator
Thank you. This concludes the Magic Software Enterprises Ltd. second quarter 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.