Magic Software Enterprises Ltd (MGIC) 2021 Q4 法說會逐字稿

Welcome to Magic Software Enterprises 2021 Fourth 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's CTO, Mr. Yuval Lavi. Magic quarterly earnings release was issued before the market opened this morning. It has been posted on the company's website 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'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.

Thank you, operator. I'd like to welcome everyone to our call today to review Magic's Fourth quarter and Full Year 2021 Financial Results. Magic finished the year on a strong note with fourth quarter revenue growing 27.2% to $133 million and on an operating margin of 14.9% compared to 14.6% in the same period of the previous year. For the full year, revenue increased by 29.4% to $480 million, and we delivered an operating margin of 13.9% compared to 14.2% in the previous year. We maintained profitability despite the increase in employee cost, which our industry and many sectors continue to face.

On a constant currency basis, revenue for the fourth quarter grew organically by 15.1%, while revenue for the year grew organically by 13%. These record results are a direct outcome of our talented team, together with the quality and diversity of our products and services validate the success of our strategy and the viability of our business, stable, profitable and with high level of visibility. Our strategic priorities are the basis for our success, continuous innovation and expansion of our offering, one; organically to new and existing clients; and two, via M&As all in order to provide exceptional value to our customers across the digital transformation journey.

These strategic elements provide us with numerous growth levers and allowing us to benefit from the robust and sticky revenue model with a significant percentage of recurring revenue.

We have delivered 19% compounded annual revenue growth rate over the past 5 years and more than doubled our annual operating income during this time from $28.4 million in 2016 to $66.8 million in 2021.

Our business is benefiting from global trends that are driving our growth. This includes, first and foremost, the demand for a wide range of top technologies, methodologies and services as SMBs continue to migrate from legacy systems to modern, flexible, on-premise or cloud-based solutions as well as the need for meeting customers' expectations for digital and more personalized experience.

The global trends of accelerating digital transformation and changing customer expectations means that enterprises must continue to modernize their systems to remain competitive. We will leverage our strongest year on record, witnessing a healthy demand and developing a growing pipeline to deliver continuous growth in 2022.

On the M&A front, Magic has demonstrated in the past a 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. We continue to explore opportunities that we would find fit to our strategy to deploy our current cash position.

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 2022.

Our fourth quarter revenue totaled $133 million compared to $105 million for the fourth quarter last year and $121 million in the previous quarter, reflecting 27% and 10% year-over-year growth, respectively.

Overall, organic growth this quarter was 18%, with 3% resulting from positive impact of currency exchange rate in the amount of $2.5 million.

Looking at the geographical breakdown of our revenues, North America accounted for 53% of total revenues; Israel, 38%; Europe, 6%; and APAC and the Rest of the World accounted for 3% of our annual and fourth quarter revenues.

During the fourth quarter, North America grew by 37% year-over-year, of which 70% organically. Israel grew by 25% year-over-year, of which 70% organically, while being positively impacted by the devaluation of the U.S. dollar versus the new Israeli shekel in the amount of $2.9 million, accounting for 28% of Israel region's growth.

For the 12-month period, our revenues in North America grew by 43% year-over-year, of which 15% organically and mainly attributed to our operations with CVS.

During 2021, CVS accounted for 14% of our overall revenues compared to 12% in 2020. Israel grew during 2021 by 21% year-over-year or 15.1% on a constant currency basis, of which 58% organically.

Turning now to profitability. Our non-GAAP gross profit for the fourth quarter of 2021 was $38.7 million, up approximately 19.2% compared to $32.5 million in the same period of the previous years.

Our non-GAAP gross margin for the fourth quarter of 2021 decreased 200 basis points to 29.1% compared to 31.1% in the same period last year and up 80 basis points compared to previous quarter.

Our non-GAAP gross margin for the 12-month period of 2021 decreased by 230 basis points to 29% compared to 31.3% in the previous year. The decrease in our gross margin is mainly attributable to: one, the change of our revenue mix related to our software solutions compared to our professional services, accounting for approximately half of the decrease in gross margin; and two, the increase in employee payroll costs due to increased demand for digital, cloud, data and core system professional experts, which lowered our weighted average professional service gross margin to 20% in 2021 compared to 21.3% in 2020.

The breakdown of the revenue mix for the 12-month period of 2021 was approximately 19% related to our software solution and 81% related to our professional services. This compared to 23% related to our software and 77% related to our professional services in 2020 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 enableIT acquired during the second quarter of 2021 to our professional service business segment, contributing $19 million to our top line this year.

Despite a significant change in the mix of our revenues between software solutions and professional services, the breakdown of our gross profit mix for the 12-month period of 2021 remains stable at approximately 45% of our gross profit related to our software solutions and 55% related to our professional services in 2021 as a whole, compared to 47% related to our software and 53% related to our professional services in 2020.

Moving to operational costs. R&D expenses on a non-GAAP basis in the fourth quarter totaled $3 million compared to $3.1 million in the same quarter of last year and $3 million in the previous quarter. Our non-GAAP operating income for the fourth quarter increased 29.5% to $19.8 million compared to $15.3 million in the same period last year. This reflects an operating margin of 14.9% for the fourth quarter compared to 14.6% in the same period of the previous year and 13.6% in the third quarter of 2021.

Our non-GAAP operating income for the year increased 27% to $66.8 million compared to $52.6 million in the period -- in the prior year. This reflects an operating margin of 13.9% for the year compared to 14.2% in the prior year.

Our non-GAAP tax expenses for the year totaled $11.3 million compared to $8.8 million in the previous year. Our effective tax rate for the 12-month period was 18% and 17%, respectively, for the prior year. We expect our effective tax rate in 2022 to be in the range of 19% to 20%.

Our non-GAAP net income for the fourth quarter increased 22.5% to $12.6 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. Our non-GAAP net income for the year increased 23.5% to $46 million or $0.94 per fully diluted share compared to $37.2 million or $0.76 per fully diluted share in 2020. Diluted earnings per share for the year reached $0.94, up approximately 24% or 74% in 2020.

Turning now to the balance sheet. As of December 31, 2021, our cash and cash equivalents, short- and long-term bank deposits and marketable securities amounted to approximately $97 million, a decrease of $3 million from the prior quarter. Our total financial debt as of December 31, 2021, amounted to $37 million compared to $43 million in the previous quarter.

In our press release issued today, we announced that Magic Software Enterprises Board of Directors has declared a semiannual cash dividend in the amount of $0.216 per share and in the aggregate amount of approximately $10.6 million for the second half of 2021, which together with the dividend distributed for the first half of 2021 in an amount of approximately $11.5 million, reflects 75% of our net income and 48% of our non-GAAP net income for the year. From a cash flow perspective, we generated $40.5 million from operating activities for the year compared to $52.3 million in 2020. The decrease in our cash flow from operating activity was mainly attributable to the increase of our working capital resulting from our top line growth in 2021.

I would like to turn now to our guidance for 2022. As we are witnessing a healthy demand and developing a growing pipeline to deliver continued growth in 2022, we anticipate revenue in the range of between $535 million to $545 million, reflecting annual growth of 11.5% to 13.5%.

In summary, this was a strong, challenging and overall exceptional year of execution on many fronts, and we want to congratulate the Magic global team for their outstanding work in 2021. The results we delivered show that our strategy is working and that by focusing on our investment to deliver profitable growth, we can significantly enhance shareholder value.

With approximately 3,700 talented employees spread globally compared to 3,000 at the end of 2020 and our 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 turn over -- I will turn the call over to operator for questions.

(Operator Instructions) The first question is from Chris Reimer of Barclays.

Congratulations on the strong results. Just picking on the revenue guidance, I was wondering if you could give us some more color on where you see the growth coming from. You mentioned strong pipeline. But could you give us some color on what verticals you're seeing that come from? And in terms of how you feel the company is positioned in terms of leveraging current customers versus acquiring new customers?

In terms of the vertical, we are very strong and we are very strong in the banking industry, on health care, on the high-tech and start-ups, which, by the way, were somewhat impaired during 2020 with the COVID situation. We saw a recuperation during 2021, and we still see significant demand in 2022. This is in terms of the markets that we operate in.

In terms of existing customers versus acquired and new customers, 80% of our revenues are normally generated by our existing long-term relationship with our customers, seeing us their preferred vendor of choice to all of their transformation, digital transformation journey.

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Yes. I didn't hear the end of the question -- the answer.

We think that 80% of our business is relying on our existing relationship with our customers and 20% are resulting from -- every year, resulting from new customers.

Okay. And just touching on the employee levels. You mentioned the 3,700. I think that's up from last year even. But how do you feel about your staffing levels? And are you seeing higher levels of attrition?

We definitely see higher levels of attrition. Fortunate enough, we are dealing with that better than what we hear from our colleagues in different companies. But yes, it's a struggle. It's quite hell for us in our business, especially from start-ups, unicorns and these kinds of guys that are not measured on their bottom line. They are paying like a lot of money now, way more than what we are paying. In some way, we are managing it, but yes, it is a struggle.

(Operator Instructions) The next question is from Maggie Nolan of William Blair.

This is Ted on for Maggie. I wanted to ask about the guidance. How much conservatism have you included in guidance? I mean, in the past, you've talked about 10% to 12% growth being kind of the long-term guidance. It sounded like the fourth quarter, you're exiting more at 18%. So just curious how much conservatism you've embedded within the guidance?

Let's put it this way. I would say we are usually rather conservative. Taking into account what's going on right now in Ukraine and Russia, we do have operations in both sides. So one of them is not working currently. The other one is supposed to suffer from sanctions. So yes, we were quite conservative.

Got you. And can you maybe quantify that for us? Or just maybe provide us a framework for how much of a drag you're maybe seeing from operations in those 2 countries in terms of how many employees you have and just maybe current level of utilization in the countries.

In Russia -- again, we spoke right away with all of the customers that are currently engaged with us -- that start from Russia, with our Russian employees. All of our agreements are signed between our either Israeli or U.S. or European entity. There is no direct link anyway between a client -- business link between a client and the Russian entity besides the fact that the actual program or developer is situated in Russia. Today, we have around 200 people in Russia. Again, we didn't hear any of our customers, and we spoke with all of them. Once this scenario started, nobody is pushing back on working with our team. If we will be in a situation where there will be some sanctions, we can always try and relocate necessary amount of people from Russia either to Europe or even to Israel in order to continue the operation.

In Ukraine, we are currently having around 100 employees. As we said, it's not a material size for us. It's not a material size -- in terms of size, something around $6 million a year.

Currently, as Guy mentioned, the operation totally shift for the last few days, and we'll see how things are evolving. But we can replace -- obviously, we can replace most of the service or some of the service that we are providing our clients not via our Ukraine operation but rather via other sites.

We also moved our traffic, our Internet connectivity from Russia directly to Israel instead of via Europe. So any sanctions from that point can be overcome.

Got you. That's helpful. And I just maybe misheard, you said your operations have ceased in Ukraine. Is that correct?

Yes. Currently, yes.

Okay. And then maybe switching gears here. I wanted to talk about maybe just kind of the revenue mix between software and services and just what's contemplated in your full year guidance and how you expect that to impact gross margins.

Basically, over the last year, we saw a 10% increase in our software activity versus a 35% increase in our professional services, which was 50% generated from M&A and 50% from organic activity. Despite the fact that our software is significantly smaller in size than our professional services, we see while following this growth that we saw an improvement in our operating margin from 21% in 2020 to 25% in operating margin in 2021. This allowed us, by the way -- and opposite on the professional service side, our operating margin declined from 21% to 20%, not material but still a certain decline. This mixture, the benefit that we got from improvement and improved activity in our software side versus our professional service manager, allow us to continue and maintain the 14% operating margin that we show over the last 5 or 6 years.

Moving forward, we expect this guidance or this behavior to continue to next year. We anticipate our gross margin to remain at around 29%, and our operating margins to remain at around 14%.

Plus.

Okay. That's very helpful. And then maybe just kind of circling back to the attrition commentary. So I understand the -- seeing higher level of attrition. Maybe can you just touch on the -- what you have seen in terms of the attrition trends over the last couple of quarters and maybe even just here into January and February of 2022, what you're seeing there.

So I would say that in most cases, people are getting offers from kind of start-ups or unicorns that you -- we basically cannot compete. It's not that much in our case but still, it's not convenient for us. We see it everywhere. We see it in -- even in India, we see it definitely in Israel, to some extent in the States. I think during January, February '22, I cannot say that it stopped completely, but there is a slowdown. So we feel it less in '22. That's where we stand.

Okay. Great. And then maybe just terms -- last questions from me here. So housekeeping, what was the organic growth embedded in kind of the full year 2022 guidance? And then what are you seeing in terms of just the M&A pipeline?

What we -- the guidance for '22 is just the organic part. We didn't include any M&A because, as you know, M&A is like either 1 or 0, it is either happening or not. So we cannot -- we didn't want to put it as part of the guidance. We have put only the organic part.

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

Yes. Thank you, everyone, for joining. Another good quarter of Magic Software. We definitely hope to bring you some more good news in the near future, and see you on our next quarterly conference. Thank you.

Thank you. This concludes the Magic Software Enterprise Ltd. Fourth Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.