Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Magic Software Enterprises Ltd (NASDAQ:MGIC)
Q2 2020 Earnings Call
Aug 13, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Magic Software Enterprises 2020 Second 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'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 our Investor Relations section of the company website.

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

Asaf Berenstin -- Chief Financial Officer

Thank you, Yanni. 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 to our 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, which are mainly coming from expansions of our business in North America and 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 formats and addressing the challenges they face. As markets continue to adapt to the new normal, we see that the current business disruptions 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 wide range of top technologies, methodologies, and services for 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 customers' 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 stream 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 these challenging business environment as we help customers adapt to new and unique challenges to COVID-19. In return, these sense of secure are repeating revenues while increasing sales with our existing customer base, delivering additional services to enable our customers' growth and success. Our priority remains executing on our growth strategy.

For the remainder of 2020, I'm 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 investments. We continue to see the growth in sales to our existing customers, which proves 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 their restricted travel and lack of face-to-face events. We have accelerated the online engagement model and being very active with webinars and remote user groups to replace the face-to-face sessions.

Overall, we see that the actions we have taken provided us the necessary flexibility and operating efficiency within the current circumstances. Solid demand for our 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 margins. 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 remainder 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 our revenue in the telecom industry. As a result, our second quarter results reflect the 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 of our 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 revenue. Most of our growth in absolute number was traditionally from North America and Israel, which continue to be our strongest territories. 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 solutions 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 solutions 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 expenses 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 measurements 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 increased 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 U.S. dollar versus the new Israeli shekel during the second quarter of 2020, our financial income -- 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 marketable 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 shareholders with respect to the second half of 2019, $4.4 million related to dividend distribution to non-controlling interests, and $4.3 million related to M&A activities, mainly toward the acquisition of non-controlling interests.

In our press release issued today, we announced that Magic Software Enterprises Board of Directors has declared a semi-annual 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 it's resilience in these challenging environment. From an operational perspective, we are a software company which fortunately allowed us to remotely work from home or from client's side. As a result, we have very high visibility of our revenue stream from existing customers. This path 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.

Questions and Answers:

Operator

Thank you. [Operator Instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays -- Analyst

Hi, everyone. Thanks for taking my questions. I have a couple. First, you mentioned the strong demand you are seeing driving by COVID-19, pushing companies to turn into more digital and throughout their transformation projects. 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 projects will take more time to kind of develop and turn into additional revenue?

Guy Bernstein -- Chief Executive Officer

Hi, Tavy. Yeah, definitely we are 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're surprised, we're surprised for the good and not for the bad.

Tavy Rosner -- Barclays -- Analyst

Okay, that's helpful. And then, you guys talked about the telecom market in your prepared remarks. Can you elaborate what's going on there and what are your expectations for the second half?

Asaf Berenstin -- Chief Financial Officer

In 2019, I can tell you, we experienced a very good start for the year, kind of, in conjunction with the merger between Sprint and T-Mobile. The -- 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 provide to such companies. This is something that following the approval of the merger in 2020 started to realize, but it happened starting, I would say, the -- close to the end of the second quarter and we expect an improvement on that. But if I take the first half of 2020 versus the first half of 2019, there was -- as you see -- 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 expect it to be at a 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 -- Barclays -- Analyst

Okay, that's very helpful. And then perhaps a last one for me. COVID has put a lot of restriction on traveling and this is a place where you save money and 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? 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 -- Chief Financial Officer

I can tell you that...

Tavy Rosner -- Barclays -- Analyst

Thank you, guys.

Asaf Berenstin -- Chief Financial Officer

I can tell you that another thing that works for our benefit is that until today there was always a pressure on salaries. We have lots of people on the professional service side of the business and at the moment, based on the economic environment, so there is no much pressure 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 hand, you still have clients pushing on the -- on discount or run rates. So I think that overall, this -- kind of, supposed to support our growth and not reduce it.

Tavy Rosner -- Barclays -- Analyst

That's very helpful, thank you very much.

Operator

The next question is from Kevin Dede of HCW. Please go ahead.

Kevin Dede -- H.C. Wainwright -- Analyst

Afternoon, gentlemen. 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 cost this half, please.

Asaf Berenstin -- Chief Financial Officer

So basically, we managed to save on the SG&A. We saved something around $1.1 million, $1.2 million compared to a -- 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 had people on unpaid leave. We -- the -- some had salary reduction, we are travel constrained. 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 see that Magic always -- at least Magic, as a 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 of -- as I'm with the company.

Kevin Dede -- H.C. Wainwright -- Analyst

Can you talk to your headcount at the end of the June quarter and what your expectations might be, given prevailing circumstances?

Asaf Berenstin -- Chief Financial Officer

Headcount didn't change much. We're 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, 70% of that is in the U.S., 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 -- Chief Executive Officer

Well, the vast majorities are billable people we're looking for.

Kevin Dede -- H.C. Wainwright -- Analyst

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 outsourced people at your clients? Maybe just some insight on that overarching trend, please.

Guy Bernstein -- Chief Executive Officer

Okay, so I'll divide it into this -- your question into two. One part is that every now and then we have renewal of -- or a new sale of our 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 as a result, we did the last transaction, it was -- it is a service-based company and therefore it affects the ratios between services and software.

Kevin Dede -- H.C. Wainwright -- Analyst

Okay, thanks, Guy. 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. Can you speak to that a little bit?

Guy Bernstein -- Chief Executive Officer

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 papers. So we don't see a pressure on companies that want to be sold, to sell their operations. Still we have quite a nice pipe, 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 -- H.C. Wainwright -- Analyst

Okay. Do you foresee maybe getting deals done over the remainder of this year or early next...

Guy Bernstein -- Chief Executive Officer

Definitely.

Kevin Dede -- H.C. Wainwright -- Analyst

...while -- before the COVID thing sort of gets resolved?

Guy Bernstein -- Chief Executive Officer

We do have few companies in the pipe, like in quite advanced situation. Hopefully it will be closed.

Kevin Dede -- H.C. Wainwright -- Analyst

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 -- Chief Executive Officer

R&D development is focusing again on 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 a 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 -- H.C. Wainwright -- Analyst

Okay. Any insight on the cost side of that? It just seems...

Asaf Berenstin -- Chief Financial Officer

Most of that -- most -- 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 hand, and on the other hand, we also, during the corona time, had some people that were on -- utilizing their vacation days or were on some kind of unpaid vacation. So this is something that contribute to the deduction of the cost just for the second [Speech Overlap]

Kevin Dede -- H.C. Wainwright -- Analyst

Okay, [Indecipherable]. So should you kind of expect things to bounce back to more historical norms in the quarter?

Asaf Berenstin -- Chief Financial Officer

Yeah, something around the $3 million.

Kevin Dede -- H.C. Wainwright -- Analyst

Okay. Okay. All right, I'll cede the floor. Thank you for entertaining my questions, gentlemen. Nice job.

Guy Bernstein -- Chief Executive Officer

Thank you.

Asaf Berenstin -- Chief Financial Officer

Thank you.

Operator

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

Asaf Barel -- Oppenheimer -- Analyst

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 -- Chief Financial Officer

In terms of the sector that we managed to compensate with, it's basically the finance sector where we are very strong in, the healthcare -- we had some improvement on the cyber security. Companies are utilizing our people, we have around 40, 50 people that are working around the cyber security and we found people are trying -- the 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 is not much to say. This is a -- we are keeping -- we are pretty much keeping with our dividend policy. We took the second half where we distributed only 50% of the -- of our distributable profits, just because back at the -- during April, May, there was more unclear, let's say, sight. And now we are -- we feel that we are back on track. We have 90 -- we have $91 million, $92 million in -- on our cash. The company is generating $15 million per quarter from operating cash flow, leverage is low.

Asaf Barel -- Oppenheimer -- Analyst

Yeah. Okay, that's helpful. Just on -- so kind of on a go-forward basis, we know that the mix is favoring professional services increasingly and we really see it clearly in the gross margin. I mean, where do you guys see the gross margin on a normalized basis? Is it closer to the 30.5-ish than 31-ish or is closer to 32%? I know it depends on where growth goes depending on segment that's there. Just any commentary there.

Asaf Berenstin -- Chief Financial Officer

It's closer to the 32%.

Asaf Barel -- Oppenheimer -- Analyst

Okay. Yeah. That's all from my end.

Operator

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

Ted Starck-King -- William Blair -- Analyst

Hey, this is Ted on for Maggie. So I think in the press release -- and you mentioned it at the top in your prepared remarks, you said you're gaining traction with 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 -- Chief Financial Officer

I think -- I don't think that -- mentioning new logos and I'll tell you why it's something that we feel that will 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 kind of fifth largest accounts 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 pipe. This is something that can go to $100,000 or $200,000 or $500,000, depends on the deal.

So this quarter we had Santa Clara for example that they acquired our low-code development platform with a deal of around $200,000, a three-year contract to develop low-code business application and then there are numerous, let's say, numerous examples like that. In terms of the improvement on the professional services side, and I think that we are just being on the -- 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 waves on the financial sector. We are riding those waves on the healthcare sector with CVS, with the two largest healthcare providers in Israel. Defense sector is also 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 in the Israeli market. So we're feeling pretty much benefited from that. Any other question?

Operator

The next question is from Maggie Nolan of William Blair. Please go ahead.

Ted Starck-King -- William Blair -- Analyst

Hey, Asaf. 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 -- Chief Financial Officer

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.

Ted Starck-King -- William Blair -- Analyst

Okay, thank you. That's helpful. And then looking toward 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 -- Chief Financial Officer

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.

Ted Starck-King -- William Blair -- Analyst

Okay and then just related, I guess, to the holiday season this year between Q3 and Q4, any comments there?

Asaf Berenstin -- Chief Financial Officer

No, no, not something special. We have the Jewish holiday season in -- during April and Q3 is kind of the full -- basically a full quarter that we have in September -- the -- again the New Year holiday season here in Israel, but this is a -- 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.

Ted Starck-King -- William Blair -- Analyst

Okay. Okay, thank you. And then last question from me. Can you talk about the health of the CVS relationship and where you stand with that? Thanks.

Asaf Berenstin -- Chief Financial Officer

Basically, I can tell you that business are good. We are improving our operation 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.

Ted Starck-King -- William Blair -- Analyst

Very good, thanks guys.

Operator

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

Guy Bernstein -- Chief Executive Officer

So, thank you very much everyone for joining our call today and we definitely hope to bring you some good news in the near future. Thank you.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Asaf Berenstin -- Chief Financial Officer

Guy Bernstein -- Chief Executive Officer

Tavy Rosner -- Barclays -- Analyst

Kevin Dede -- H.C. Wainwright -- Analyst

Asaf Barel -- Oppenheimer -- Analyst

Ted Starck-King -- William Blair -- Analyst

More MGIC analysis

All earnings call transcripts

AlphaStreet Logo