Magic Software Enterprises Ltd.
Q1 2021 Earnings Call Transcript

Published: 10 May 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Magic Software Enterprises' 2021 First 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. 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 Vice President of Technology & Innovation, Mr. Yuval Lavi. 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.

[Asaf Berenstin:]

Thank you, operator and thank you everyone for joining us today as we report our first quarter 2021 financial results. During the call today, I will review highlights from our first quarter results and provide an overview of our achievements. Our first quarter results demonstrate our continued focus on supporting our existing customers and closing new deals and a continued solid execution of our priorities of topline growth as we reported 26% year-over-year growth in the quarter with sales mainly coming from the continued expansion of our business in North America and in Israel. Our first quarter revenue totaled $107.3 million compared to $85.2 million for the first quarter last year, reflecting a year-over-year growth of 26% compared to the first quarter of 2020. The organic revenue growth was 15.8% with a balance of 10.1% resulting from the consolidation of acquired entities, which were completed after the first quarter of 2020. These achievements deliver a 37% increase in operating income with operating margin reaching 14%, up from 12.9% last year. Magic Software is a global company operating across multiple markets and offering broad IT business service portfolio. Our strategy allows us to balance our growth, resources, investment, and risk across regions and markets. Over the past quarter, we continue to experience strong demand for our digital transformation offerings. We are currently increasing resources in order to support existing transformation projects as well as new business towards the second half of the year, while carefully managing and controlling our expenses.

[Operator:]

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

[Ted Starck-King:]

Hi, this is Ted on for Maggie. I wanted to follow-up on your statement about increasing resources for transformation. So, we've been hearing a lot about the war for talent and some peers in the industry are facing headwinds from wage inflation. Could you provide an update on your hiring plans for 2021 and any color around what you're seeing from a wage standpoint?

[Guy Bernstein:]

For us at the end it is based on our pipeline and project, so definitely if we continue to grow like, I don't know 15%, 20% per annum, we need to increase forces. It's a battle out there. Salaries are increasing all the time. And we are looking for creative ways to find people overseas, whether it's in India, whether it's in Eastern Europe. We're checking all the possibilities, but yes, it's a struggle.

[Ted Starck-King:]

All right, thanks. It's helpful. And then in terms of guidance, can you talk about just kind of a revenue cadence for the rest of 2021? It sounds like maybe with that new business in the second half and maybe it's back half loaded, just any thoughts around the cadence? Thank you.

[Asaf Berenstin:]

I think that since we're still at the beginning of the year and although in Israel, it seems that we are pretty much managed to overcome the negative impact of the COVID-19, we still see some struggles in the U.S., although in the clients that we at least provide services, it's not something that impact the business, or that we saw that reduces our backlog with them. I think we are a little bit conservative. But -- and most likely, we will even update the revenue guidance also in the next quarter. But it's a very strange period of time for us. We prefer to remain conservative.

[Ted Starck-King:]

Definitely. What do you view as the medium term and long-term sustainable organic growth rates for software and for professional services?

[Guy Bernstein:]

The way -- I think in the previous years, it was I would say probably between 10% and 12%, something like that organic and the rest came from M&A. I believe we can keep on doing so.

[Ted Starck-King:]

Okay. Any thoughts regarding kind of the software piece of that organic growth rate?

[Guy Bernstein:]

I think it's the same. We may face like better year or a year which is less good, but all-in-all, if we check it over, I'll say five years, you will see that it's the same.

[Ted Starck-King:]

Okay, great. Thanks.

[Operator:]

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

[Chris Reimer:]

Hi, this is Chris on for Tavy. Thank you for taking my question. Regarding operating expenses, can you give some color around expenses this quarter, relating to maybe if anything was impacted still from COVID items, or if anything was under or over something that would be more sustainable, or if the levels we're seeing this quarter is sustainable going forward?

[Asaf Berenstin:]

The things that what we see today and then we can even see it in the results of the company where we are doing the fourth quarter of every year is considered to be our strongest quarter. We see that in the first quarter, we started in a very strong momentum and we are showing pretty much the same level of operation as we had in the fourth quarter. It is something that was across the organization on the software division in our professional service division.

[Chris Reimer:]

Okay. Thank you. Regarding customers, where do you see demand coming from in terms of verticals? And have there been any major changes as we move to a post-corona environment, for example, in terms of customer budgets or spend around being projects, et cetera?

[Guy Bernstein:]

I think we see it across the board one sector that was a bit -- that started a bit less -- we felt some weakness with the pandemic was the startup companies that we served. So, it was -- it started with a slowdown at the beginning of the pandemic. And now it's packing up again. So, overall, we see it across the board. Organizations are going faster towards the transformation. Enjoy it.

[Chris Reimer:]

And then just touching on M&A if I can, have you seen anything relevant in the pipeline? And have any of the dynamics changed, maybe around valuation or competition level?

[Guy Bernstein:]

Mostly, we see small companies that we swallow them like -- easily. We don't have anything which is material insights.

[Chris Reimer:]

Not insight, okay. Great. All right. Thank you very much. That's it for me.

[Operator:]

The next question is from Asaf Barel Chandali of Oppenheimer. Please go ahead.

[Asaf Barel Chandali:]

Hey, guys. Congrats on another great quarter and thank you for taking my questions. Maybe just to kind of start on the updated guidance. You mentioned that maybe there are some conservatism kind of baked in, but obviously, if we take the 1Q run rate and then multiply it by four, we're getting to roughly the full year guide. So, is there anything that you're seeing in 2Q that would imply any sort of a sequential decline? Any maybe commentary you can give on how you're seeing the quarter so far?

[Asaf Berenstin:]

No, we don't see any decline. I think what we do see that we see strong demand, but something that we expect and as we say that we are hiring just for that is supposed to make the difference over the second half of the year. This is why we say that for the time being, we feel comfortable that we will be something very close to the upper part of our range of guidance. And most likely, we will update it in the second -- at the end of the second quarter.

[Asaf Barel Chandali:]

Okay, great. In terms of currency impact, what was the -- if you guys have it in a funny way, I didn't hear it on the call; let me know if I missed it. The constant currency revenue growth, and then what would the constant currency number be for the full year guide?

[Asaf Berenstin:]

Again, it wasn't material in mostly -- I think except for in -- especially if you compare Q4 and Q1 currency exchange impact was close to none. Especially not material versus the first quarter, it was something around $2 million in the topline, but it reduces to around a few $100,000 on the bottom-line because most of the work that we do, we have a foot on the ground in the territories where we generate the project. So, if we work in Europe, so we have people in Europe, if we work in the States, the same, and if we work in Israel, the same. So, the company is not exposed to exchange rate differences between its cost and it's -- the currency, its revenues is nominated.

[Asaf Barel Chandali:]

Okay, great. Yes, very fair. Any commentary you can maybe give us on end markets, whether that be healthcare, Telco, defense, anything you guys are seeing. I know it's a big market and these are relatively small revenue figures for the broader kind of maybe professional services market, but do you feel you're taking the share, any -- maybe kind of commentary on the competitive front?

[Asaf Berenstin:]

As you said, Magic is characteristic by the fact that we don't have except for TBS, which is around, let's say 13% of our overall revenues, we don't have a material -- another material a customer. So, we spread it out many different customers in the different sectors that we -- the sectors that we operate in. Overall, we see stability and we see growth in the clients that we operate in. We try to once we land an account, we try to expand into different types of services that we can offer him for it's -- we like to call it digital journey with us. And this is something that that’s translated to the growth that you see. Most of the business that we generated this quarter is very -- is construed from our existing customer base. I think that around 60% -- around 60% of the growth in Q1 versus the respective period was from organic activity, as I said, around a -- close to 16% and most of it comes from existing clients. So, we see the demand, we see that we have the ability to grow within the community that we land and we stay optimistic with that.

[Asaf Barel Chandali:]

Okay, great. And then just on gross margins here, you mentioned some one-time items that depressed gross margins this quarter, and obviously, year-over-year, that number is going to maybe kind of trend down slightly over time as the revenue mix shifts towards professional services. But just kind of on a normalized or sustained basis, at least for 2021, 2022, can we assume for the rest of the year, we see kind of the 22%, 23% margin for professional services and closer to 66% number for software, that would imply around 31%-ish. Obviously, we've seen similar numbers in late 2020, just to kind of confirm, there's no kind of structural change?

[Asaf Berenstin:]

There's no structural change and the gross profit is pretty much in the area that you mentioned for the software. And for the services, I guess it would be something between the 30% -- it would be over 30%, so something between the 30% and the 31% gross profit -- gross margin.

[Asaf Barel Chandali:]

Okay, great. That's all for me and again, congrats on the very strong performance.

[Operator:]

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

[Kevin Dede:]

Hello gentlemen. Thanks for taking my questions. Curious on the breakdown just by customers, can you give us a little bit more insight on where you're seeing the bulk of the professional services versus software? I mean I'm sure it hasn't changed much from last year, but--

[Asaf Berenstin:]

So, it hasn't changed much. In the last year, it was around 22% that originated from our software division and versus 78% that was from our professional service division. In this quarter, it was 21% and 79%. We had a very decent quarter in terms of sales of licenses, despite that being the first quarter after a very good -- a fourth quarter. Significant -- though 20% of the growth came from the software division. In terms of the revenues in terms of the profits, 54% of the growth came from the software division and this is why we say that this is a hybrid company and the success of the software gives us the ability to maintain a higher level of margin compared to our peers. And it's pretty the same way as when we were in during the fourth quarter of 2020 and we keep the momentum.

[Kevin Dede:]

Okay, thanks Asaf. But traditionally, you've done -- I mean you're doing a lot of work in healthcare and telecom. Can you look at the revenue from that perspective?

[Asaf Berenstin:]

That’s not where you change in the allocation between--

[Kevin Dede:]

Customer mix.

[Asaf Berenstin:]

Yes, between the mix and again, you can see it also from the topline, you can see that we did the $107 million in May in Q1, we did $104 million. $105 million in the fourth quarter and the revenue mix was pretty much the same.

[Kevin Dede:]

Some of your customers have been holding back though, on account of COVID and now what you're saying is you're still seeing a little bit of that, but maybe not as much?

[Asaf Berenstin:]

I think that we've we started to see them releasing more projects at the end of the -- first of all, at the second half of 2020 and now we see it more still at the pipeline level. This is why we expect the second half to be better than the first half. And yet to be seen.

[Kevin Dede:]

Okay. Any sort of influence on the Sprint and T-Mobile merger, is that -- where is that going, as you guys see it?

[Asaf Berenstin:]

I think it's not materially. They did a very stable quarter, very similar to what we did in the Q4. Ericsson was stable and the same as the T-Mobile and our telecom project. So, no change. So, there wasn't any -- so the growth didn't came from the telecom business, it came more from the defense, it comes more from the financial service sector, it comes from the healthcare sector. I would say that it's stable in the -- on the telecom side.

[Kevin Dede:]

Okay, that's helpful. Thanks Asaf. You've also on the call -- Yuval can you give us an update on where you are with the PowWow integration? And when you expect the next XPI version to be released? You guys still on track for that? I know last time, we talked about it, you expected it sort of springtime, early summer?

[Yuval Lavi:]

Yes, we're still looking to keep it on track. The challenge -- as Asaf mentioned, in most of our territories, we managed through overcome the challenges of COVID. But this project specifically is located with a team in India, where you know, there is a big challenge there with COVID. But we still trying to overcome those challenges and keep it on track.

[Kevin Dede:]

Okay, have you released like an alpha or a beta or anything and have you gotten any feedback on it?

[Yuval Lavi:]

We have -- we're in the alpha stage, which is the purely internal yet with our branches and not with the customers. We're looking forward like in the next two months to start doing it with the kind of house player customers as we call them.

[Kevin Dede:]

Okay, so you really don't have any sort of commercial feedback on it yet? Still too early?

[Yuval Lavi:]

Yes, it's a bit too early for that.

[Kevin Dede:]

Okay, fair enough. All right, gentlemen. Asaf one question, just on the debt, there's $23 million, what do you guys paying on that? What's the plan given that you're generating so much cash, why are we carrying the debt at this point?

[Asaf Berenstin:]

First of all, most of it comes as -- a big chunk of it comes from a debt that we took in 2016, where we wanted to finance one of the acquisition that might -- one of the more larger, let's say, type of acquisition that we did when we acquired Roshtov in Israel. So, this is something that still is on our balance sheet, we pay around 2.6% -- fixed rate of 2.6%. So, it's not heavy on our cash flow, it allows us to give the flexibility of companies to do the acquisition that they want to do and stick with the 75% dividend policy that we maintain for -- since 2012.

[Kevin Dede:]

Okay. I know part of the M&A policy is to buy a little bit into a deal and then buy the entire company over time as operations work out for you. Where are you on--?

[Asaf Berenstin:]

Yes, I don't think this is the right words to describe it. So, normally when we buy an asset, a company, we want to keep the managers, the founders, they motivated, they are billable people. They see the opportunity of joining forces without existing teams. As we normally say these companies come from the, from the division managers that they working in inside of Magic. So, these are partner of our companies that we are familiar with their businesses. So, for them, it creates a good future. It creates a good upside. So, you create, like, a balancing in terms of expectations, both from us, with the price that we want to pay and the seller side, in the upside that he can achieve. And this is why most of the acquisitions that we do, it turns out that they were rather small, but we managed to multiply it and increase them significantly over the long-term.

[Kevin Dede:]

So, I know you said there's nothing material near-term, is there anything maybe smaller, I was a little confused by Guy's remarks. I can't tell if anything happened in the -- during the March quarter or if there's anything you expect?

[Asaf Berenstin:]

Yes, we expect to close. I think what Guy meant is that in every given year, we managed to close between one or two small companies that we take in. I expect one company to -- that we will manage to close by the -- during, let's say, by the end of the second quarter. And there is another very small company that is a long Magic partner of ours, an application company. But it's very small, they're doing like something like $1.5 million in terms of revenues. They don't have any continue generation to take over the company. We know -- we support them for many, many years. So, for us, in order to step in, it's very easy and then try and upsell to the client that they have is something that we do over time in the course.

[Kevin Dede:]

Okay. Are -- well, one, you mentioned was an application company. So, that's support on the software side?

[Asaf Berenstin:]

Yes, that's a very small. As I said, it's only $1.5 million in terms of revenue, it's not significant.

[Kevin Dede:]

Okay. Okay. Any features or functionality there that are interesting to note?

[Asaf Berenstin:]

No, it's -- again, it's very vertical, it's not a technology, it's an application. So, for us, we see sales have the opportunity to continue to support their customers and continue the lifespan of the application on one hand. And on the second hand, give access to our experts and try to get more business in other areas of their business, mostly in the IT.

[Kevin Dede:]

Understood. Okay, thank you for entertaining my questions, gentlemen. Appreciate it.

[Operator:]

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

[Guy Bernstein:]

Thank you again for joining us for the quarterly call and we sure hope to see you on the next call and bring you some more good news. Thank you.

[Operator:]

Thank you. This concludes the Magic Software Enterprises Limited first quarter 2021 result conference call. Thank you for your participation. You may go ahead and disconnect.