Magic Software Enterprises(MGIC) - 2024 Q4 - Annual Report

Introduction and Forward-Looking Statements Company Overview Magic Software Enterprises Ltd. provides global software services, IT outsourcing, and low-code application platforms to clients in 50 countries - The company operates in four main areas: (i) software and IT outsourcing services, (ii) application development and business process integration platforms, (iii) vertical software solutions, and (iv) cloud-based digital transformation services15 - Key proprietary platforms include Magic xpa (low-code application platform), AppBuilder (mainframe-grade application platform), and Magic xpi (application integration platform)20 - The company offers specialized vertical solutions such as Clicks™ for healthcare, Hermes for air cargo, HR Pulse for human capital management, and FactoryEye for smart manufacturing18 23 - As of the report date, the company has approximately 3,787 employees and serves customers in about 50 countries through a network of partners and direct operations19 Cautionary Note Regarding Forward-Looking Statements This report contains forward-looking statements subject to risks from M&A integration, sales cycles, competition, cybersecurity, Israeli operations, and the Matrix IT merger - The forward-looking statements are based on current beliefs and expectations and are subject to risks that could cause material differences in actual results30 - Key risks highlighted include M&A integration, lengthy development and sales cycles, competition, managing operational changes, cybersecurity breaches, risks related to operating in Israel, and the proposed merger with Matrix IT33 Key Information Risk Factors The company faces significant business, investment, and operational risks, including M&A integration, market competition, cybersecurity, and geopolitical instability in Israel Risks Related to Business and Industry The company faces business and industry risks from M&A integration, product dependency, lengthy sales cycles, macroeconomic factors, intense competition, and cybersecurity threats - The M&A growth strategy carries significant integration risks, including combining different cultures, IT systems, and retaining key employees and customers. The company completed several acquisitions in 2023 and 2024, including Theoris Group Inc50 51 53 - A significant portion of revenue comes from a limited number of core product families (e.g., Magic xpa, Magic xpi, Clicks, Hermes), making the company vulnerable to decreased demand for these products57 58 - The company's two largest clients accounted for 13.2% of revenues in 2024, down from 16.8% in 2023. This decrease was partly due to a major client suspending significant services in late 202384 337 338 - A material weakness in internal control over financial reporting was identified as of December 31, 2024. Documentation supporting certain revenue cycle controls for U.S. entities was not comprehensively retained, limiting management's ability to evidence control performance147 148 - The company faces intense competition from multinational IT providers, offshore firms, consulting firms, and specialized service providers. Some competitors have greater financial and marketing resources88 89 Risks Related to an Investment in Our Ordinary Shares Investment risks include share price volatility from dual listing, controlling shareholder influence, and potential adverse U.S. tax consequences (PFIC/CFC) - The company's Ordinary Shares are traded on both the NASDAQ Global Select Market (in USD) and the Tel Aviv Stock Exchange (in NIS), which may result in price variations152 - As of April 1, 2025, Formula Systems (1985) Ltd. beneficially owns approximately 46.71% of outstanding Ordinary Shares, giving it controlling influence over matters requiring shareholder approval156 - U.S. shareholders may suffer adverse tax consequences if the company is classified as a Passive Foreign Investment Company (PFIC) or a Controlled Foreign Corporation (CFC). The company believes it was not a PFIC for the 2024 taxable year but cannot provide assurance for future years159 160 Risks Related to Our Location in Israel Operations in Israel expose the company to political, economic, and military instability, including the ongoing conflict and potential employee call-ups - The company is exposed to political, economic, and military instability in Israel, where its headquarters and significant R&D facilities are located167 168 - The war with Hamas that began on October 7, 2023, and hostilities with Hezbollah have led to the call-up of over 350,000 IDF reservists, including approximately 250 of the company's Israeli employees, which could disrupt operations169 170 178 - Provisions of Israeli law, such as those regulating mergers and tender offers, may delay, prevent, or complicate an acquisition of the company, potentially depressing the share price181 Risks Related to our Proposed Merger with Matrix IT The proposed merger with Matrix IT carries risks of unrealized benefits, integration challenges, and failure to obtain regulatory or shareholder approvals - On March 11, 2025, the company entered into a non-binding MOU for a reverse triangular merger with Matrix I.T Ltd., which is also controlled by Formula Systems183 - Key risks include the failure to realize anticipated benefits, the possibility of not reaching a definitive agreement, and disruptions from the complex integration process184 186 - The merger is contingent on regulatory approvals and approval by a special majority of minority shareholders of both companies, which may delay or prevent the merger187 189 Information on the Company History and Development Founded in 1983, the company has grown through acquisitions, with capital expenditures of $1.5 million in 2024 primarily for IT and office improvements - The company was organized in Israel on February 10, 1983, and its shares are listed on the NASDAQ Global Select Market (MGIC) and the Tel Aviv Stock Exchange190 - Recent acquisitions include Theoris Group Inc. in April 2024 for $13.1 million, K.M.T. in June 2023 for up to $16.2 million, and The Goodkind Group in August 2022 for $11.6 million191 195 196 Capital Expenditures | Year | Capital Expenditures (in millions) | | :--- | :--- | | 2022 | $4.4 | | 2023 | $1.6 | | 2024 | $1.5 | Business Overview Magic Software offers low-code platforms, vertical software, and IT professional services, focusing on customer expansion, technology trends, and strategic acquisitions - The company's software technology platforms, such as Magic xpa and Magic xpi, are low-code and designed to help organizations build and integrate business applications quickly202 204 - Key vertical software packages include Clicks™ for healthcare, Hermes Cargo for air cargo management, and HR Pulse for human capital management209 - The company has strong partnerships with major cloud providers, achieving AWS Generative AI Competency in December 2024 and being named Google Cloud EMEA Partner of the Year for Israel in 2025215 216 - The company's growth strategy includes expanding sales to existing customers, capitalizing on new technology trends, attracting new customers with new offerings, and acquiring complementary businesses280 - The company competes in the low-code and integration platform markets against players like Microsoft, Salesforce, OutSystems, IBM, and MuleSoft, based on factors like platform features, ease of use, and total cost of ownership307 308 Organizational Structure Magic Software Enterprises Ltd. operates globally through a network of wholly-owned and majority-owned subsidiaries across the US, Israel, Europe, and Asia - The company operates through a complex structure of subsidiaries across the US, Israel, Europe, and Asia320 321 - Notable subsidiaries include Coretech Consulting Group LLC (100%, Delaware), CommIT Technology Solutions Ltd (76.07%, Israel), and Hermes Logistics Technologies Limited (100%, UK)320 321 Property, Plants and Equipment The company's headquarters and subsidiary offices are leased globally, with total annual rent of $3.5 million in 2024 - The main headquarters is a leased facility in Or Yehuda, Israel, with the lease expiring in June 2033322 - Aggregate annual rent for all leased facilities, including subsidiary offices in the US, Europe, and Asia, was $3.5 million in 2024323 Operating and Financial Review and Prospects Operating Results In 2024, revenues grew 3.3% to $552.5 million, driven by IT services in Israel and Europe, despite a North American client project suspension Consolidated Statement of Operations Data (% of Total Revenues) | | 2023 | 2024 | | :--- | :--- | :--- | | Total revenues | 100.0% | 100.0% | | Gross profit | 28.6% | 28.6% | | Operating income | 10.7% | 11.1% | | Net income attributable to Magic's shareholders | 6.9% | 6.7% | Revenues by Segment (in millions) | Segment | 2023 | 2024 | % Change | | :--- | :--- | :--- | :--- | | Software Services | $92.9 | $94.9 | +2.1% | | IT Professional Services | $442.2 | $457.6 | +3.5% | | Total Revenues | $535.1 | $552.5 | +3.3% | Revenues by Geography (in millions) | Geography | 2023 | 2024 | % Change | | :--- | :--- | :--- | :--- | | United States | $250.8 | $229.1 | -8.6% | | Israel | $214.1 | $244.5 | +14.2% | | Europe | $55.2 | $62.4 | +13.0% | | Japan | $10.8 | $12.7 | +17.6% | | Other | $4.1 | $3.8 | -7.3% | | Total | $535.1 | $552.5 | +3.3% | - The revenue increase in 2024 was driven by strong demand for professional services in Israel and Europe, offsetting a decline in North America after a major client suspended projects in Q3 2023361 - Net financial expenses increased from $4.6 million in 2023 to $6.2 million in 2024, primarily due to a $2.5 million decrease in interest income from deposits370 371 Liquidity and Capital Resources As of December 31, 2024, the company had $114.6 million in liquidity, $59.3 million in debt, and generated $74.8 million in operating cash flow Key Liquidity Figures (as of Dec 31, 2024) | Metric | Amount (in millions) | | :--- | :--- | | Cash, cash equivalents, and marketable securities | $114.6 | | Net working capital | $105.9 | | Long-term debt | $36.1 | | Total debt (short & long-term) | $59.3 | Cash Flow Summary (Year ended Dec 31) | Cash Flow Activity | 2023 (in millions) | 2024 (in millions) | | :--- | :--- | :--- | | Net cash provided by operating activities | $69.0 | $74.8 | | Net cash used in investing activities | ($27.6) | ($22.6) | | Net cash used in financing activities | ($17.3) | ($45.1) | - The company has several loans with financial covenants, including maintaining equity above $150 million and specific debt-to-EBITDA ratios. As of December 31, 2024, the company was in compliance with all covenants380 381 881 - The company maintains a dividend policy to distribute up to 75% of its annual net income. In 2024, it paid $10 million in dividends and declared an additional $11.6 million to be paid in January 2025393 916 Research and Development R&D investment increased to $16.8 million in 2024, with 224 employees primarily in Israel and India, focusing on product enhancement and new applications R&D Investment | Year | R&D Investment (in millions) | | :--- | :--- | | 2022 | $13.2 | | 2023 | $13.5 | | 2024 | $16.8 | - As of December 31, 2024, the R&D team consisted of 224 employees, with 98 in Israel, 99 in India, 21 in Russia, and 5 in Japan395 Critical Accounting Policies and Estimations Financial statements under IFRS require estimates for long-term contracts, revenue recognition, business combinations, capitalized software, and put options - A critical accounting estimate involves the percentage of completion for long-term fixed-price contracts, which is based on the ratio of actual costs incurred to total estimated costs400 759 - Revenue from software licenses without significant implementation is recognized at the point of delivery. Revenue from long-term contracts with significant customization is recognized over time using the percentage of completion method405 408 771 - Business combinations are accounted for using the acquisition method. Goodwill is tested for impairment annually on December 31, and no impairment was identified for 2022, 2023, or 2024428 433 435 - Software development costs are capitalized upon establishing technological feasibility and are amortized on a straight-line basis over an estimated useful life of 3-5 years once the product is available for sale418 420 421 - Put options granted to non-controlling interests are classified as a financial liability, measured at the present value of the exercise price, with changes recognized in equity426 813 Directors, Senior Management and Employees Directors and Senior Management Leadership includes CEO Guy Bernstein and CFO Asaf Berenstin, with a board featuring external directors overseeing audit and compensation committees - Guy Bernstein serves as the Chief Executive Officer and a Director. He is also the CEO of the parent company, Formula Systems459 - Asaf Berenstin is the Chief Financial Officer and also serves as CFO of Formula Systems466 - The board includes two external directors, Sagi Schliesser and Ron Ettlinger, as required by Israeli law456 457 Compensation Total compensation for directors and executive officers was approximately $7.4 million in 2024, with specific details for the five most highly compensated officers Aggregate Compensation for Directors and Executive Officers (2024) | Category | Amount | | :--- | :--- | | Salaries, fees, commissions, stock-based compensation and bonuses | $7,132,876 | | Pension, retirement and similar benefits | $239,309 | | Total | $7,372,185 | Compensation of 5 Most Highly Compensated Officers (2024) | Name and Position | Salary | Bonus | Equity Based Compensation | All Other Compensation | Total | | :--- | :--- | :--- | :--- | :--- | :--- | | Yakov Tsaroya, CEO of Coretech | $400,000 | $1,100,376 | $ - | $9,000 | $1,509,376 | | Arik Faingold, President, Integration Solutions | $425,741 | $236,939 | $438,059 | $ - | $1,100,739 | | Idan Faingold, CEO of CommIT | $294,150 | $236,939 | $438,059 | $101,624 | $1,070,739 | | Eli Schwartz, CEO of Comblack I.T. | $421,656 | $247,299 | $ - | $ - | $668,955 | | Arik Kilman, Chairman, Software Group | $ - | $602,772 | $ - | $ - | $602,772 | - Outside and independent directors received an annual fee of $20,883 and a per-meeting attendance fee of $777 in 2024487 Board Practices The board of five directors, including external members, adheres to Israeli law and NASDAQ rules for committees and related party transaction approvals - The board of directors is currently composed of five members. Israeli law requires at least two external directors489 493 - The Audit Committee and Compensation Committee are composed of independent and external directors, in compliance with both SEC/NASDAQ and Israeli regulations504 505 507 - Transactions with controlling shareholders or in which an office holder has a personal interest are subject to stringent approval processes under the Israeli Companies Law, requiring committee, board, and sometimes special shareholder majority approval513 514 - The company has provisions for exculpation, indemnification, and insurance for its directors and officers to the fullest extent permitted by Israeli law, with coverage up to $60 million521 530 Employees As of December 31, 2024, the company had 3,787 employees, primarily in North America and Israel, with most in technical support and consulting roles Employees by Geographic Location | Region | 2022 | 2023 | 2024 | | :--- | :--- | :--- | :--- | | Israel | 1,415 | 1,554 | 1,654 | | North America | 1,965 | 1,321 | 1,387 | | Europe | 557 | 516 | 514 | | Asia | 216 | 226 | 223 | | South Africa | 8 | 11 | 10 | | Total | 4,161 | 3,628 | 3,787 | Employees by Activity | Activity | 2022 | 2023 | 2024 | | :--- | :--- | :--- | :--- | | Technical support and consulting | 3,513 | 3,001 | 3,166 | | Research and development | 257 | 256 | 224 | | Marketing and sales | 231 | 202 | 217 | | Operations and administrations | 160 | 169 | 181 | | Total | 4,161 | 3,628 | 3,787 | Share Ownership CEO Guy Bernstein holds 150,000 shares, and the 2007 Incentive Compensation Plan has 952,500 shares available for future grants to employees and directors - As of May 1, 2025, CEO Guy Bernstein beneficially owned 150,000 Ordinary Shares535 - The 2007 Incentive Compensation Plan allows for the grant of options, restricted shares, and other awards. The plan was extended until August 2027, and as of Dec 31, 2024, 952,500 shares were available for future grants536 539 540 Major Shareholders and Related Party Transactions Major Shareholders Formula Systems (1985) Ltd. is the controlling shareholder with 46.71% ownership, alongside other major institutional shareholders Major Shareholders (as of Dec 31, 2024) | Shareholder | Percentage of Ownership | | :--- | :--- | | Formula Systems (1985) Ltd. | 46.71% | | Harel Insurance | 11.52% | | Clal Insurance Enterprises Holdings Ltd. | 6.97% | - Formula Systems is the controlling shareholder with 46.71% ownership as of April 1, 2025. Formula Systems is, in turn, controlled by Asseco Poland S.A548 Related Party Transactions In 2024, the company conducted $3.6 million in sales and $5.4 million in purchases with affiliates of its controlling shareholder - In 2024, the company sold $3.6 million of services to and purchased $5.4 million of goods/services from affiliated companies of its controlling shareholder, Formula Systems515 Financial Information Consolidated Statements and Other Financial Information The company faces ordinary course legal proceedings and maintains a dividend policy to distribute up to 75% of annual net income - The company is subject to ordinary course legal proceedings which are not expected to materially affect its financial position556 - The company has a dividend policy to distribute up to 75% of its annual net income, subject to Board discretion and legal requirements557 Significant Changes Post-year-end, the company announced a non-binding merger MOU with Matrix IT and increased its ownership in subsidiary CommIT for NIS 50.4 million - On March 11, 2025, the company entered into a non-binding MOU for a reverse triangular merger with Matrix I.T Ltd. Post-merger, Magic shareholders would hold 31.125% of the combined company, and Magic would become a private, wholly-owned subsidiary of Matrix559 562 - The merger is subject to several conditions, including due diligence, obtaining fairness opinions, definitive agreement execution, and regulatory and shareholder approvals (including a special majority of minority shareholders)563 564 - In April 2025, the company acquired additional shares in its subsidiary CommIT, increasing its ownership from 68.15% to approximately 79.32% for a consideration of approximately NIS 50.4 million565 Additional Information Taxation The company is subject to Israeli corporate tax, benefiting from reduced rates, and monitors OECD Pillar Two rules, with U.S. Holders facing PFIC/CFC risks - The general corporate tax rate in Israel is 23%. However, the company benefits from reduced rates under the Law for the Encouragement of Capital Investments, with parts of its income taxed at preferred rates as low as 6% under the Special Preferred Technology Enterprise (SPTE) regime585 600 602 - For non-Israeli resident shareholders, gains from selling shares are generally exempt from Israeli capital gains tax, provided the shares are publicly traded and the gains are not from a permanent establishment in Israel. Dividends are subject to withholding tax, typically 20-30%, but may be reduced by applicable tax treaties610 615 - For U.S. Holders, there is a risk that the company could be classified as a Passive Foreign Investment Company (PFIC), which would result in adverse U.S. federal income tax consequences. The company believes it was not a PFIC in 2024 but cannot guarantee future status633 634 - The company is part of the Asseco Group, which exceeds the €750 million revenue threshold for the OECD's Pillar Two global minimum tax rules. These rules, imposing a 15% minimum tax on a jurisdictional basis, will become effective in Israel on January 1, 2026, and are being monitored for their potential impact646 647 Quantitative and Qualitative Disclosures about Market Risks The company is exposed to foreign currency and interest rate risks, primarily from NIS, Euro, and JPY fluctuations, mitigated by hedging strategies - The company's primary market risks are foreign currency exchange risk and interest rate risk653 - A significant portion of sales and expenses are denominated in currencies other than the U.S. dollar, primarily the New Israeli Shekel (NIS), Euro, and Japanese Yen, creating exposure to currency fluctuations656 - A 10% increase in the value of the NIS against the USD in 2024 would have increased revenues by $27.2 million, while a 10% decrease would have reduced revenues by $22.3 million658 Controls and Procedures Management concluded disclosure controls were ineffective due to a material weakness in revenue cycle documentation, leading to an adverse audit opinion - Management concluded that as of December 31, 2024, the company's disclosure controls and procedures were ineffective664 - A material weakness in internal control over financial reporting was identified: documentation supporting certain internal controls within the U.S. entities' revenue cycle was not comprehensively retained666 721 - Management has implemented a remediation plan, which includes hiring personnel, upgrading financial systems, and enhancing oversight, to address the material weakness669 670 671 - The independent registered public accounting firm issued an adverse opinion on the company's internal control over financial reporting as of December 31, 2024674 715 Corporate Governance and Other Matters Principal Accountant Fees and Services The company changed auditors in 2024, with fees paid to EY Israel ($126,000) and BDO Israel ($510,075) for audit and other services Auditor Fees (EY Israel) | Service | 2023 | 2024 | | :--- | :--- | :--- | | Audit | $629,000 | $27,000 | | Tax and other | $210,000 | $99,000 | | Total | $839,000 | $126,000 | Auditor Fees (BDO Israel) | Service | 2024 | | :--- | :--- | | Audit | $510,075 | | Total | $510,075 | Changes in Registrant's Certifying Accountant Effective July 31, 2024, the company replaced its independent auditor, EY Israel, with BDO Israel, following necessary approvals - The company replaced its auditor EY Israel with BDO Israel, effective July 31, 2024683 Corporate Governance As a foreign private issuer, the company follows Israeli home country governance practices, differing from some NASDAQ rules regarding board independence - The company follows Israeli home country practices in lieu of certain NASDAQ rules, such as not requiring a majority-independent board and not holding regular executive sessions for independent directors685 693 Cybersecurity The company maintains an ISO-aligned cybersecurity program overseen by the Board, with the CISO managing daily threats, acknowledging system failure risks - The company has a cybersecurity risk management system aligned with industry best practices (e.g., ISO standards) and engages third-party experts for testing and incident management689 - The Board of Directors has ultimate oversight of cybersecurity risk, receiving quarterly updates. The Chief Information Security Officer (CISO) is responsible for the daily management and assessment of cyber threats691 692 - While no prior cybersecurity incidents have materially affected the company, it acknowledges that a failure of IT systems could disrupt business and cause reputational damage690 Financial Statements Consolidated Financial Statements The 2024 consolidated financial statements, prepared under IFRS, include an unqualified audit opinion but an adverse opinion on internal controls Consolidated Financial Position (in thousands) | | Dec 31, 2023 | Dec 31, 2024 | | :--- | :--- | :--- | | Total Assets | $522,406 | $540,331 | | Total Current Assets | $256,625 | $276,199 | | Total Long-Term Assets | $265,781 | $264,132 | | Total Liabilities and Equity | $522,406 | $540,331 | | Total Current Liabilities | $141,699 | $170,305 | | Total Long-Term Liabilities | $89,763 | $68,957 | | Total Equity | $290,944 | $301,069 | Consolidated Statement of Profit or Loss (in thousands) | | 2022 | 2023 | 2024 | | :--- | :--- | :--- | :--- | | Total Revenues | $566,792 | $535,052 | $552,520 | | Gross Profit | $155,355 | $152,987 | $157,827 | | Operating Income | $61,762 | $57,108 | $61,237 | | Net Income | $46,279 | $42,502 | $43,291 | | Net Income Attributable to Equity Holders | $40,470 | $37,031 | $36,883 | Consolidated Statement of Cash Flows (in thousands) | Cash Flow Activity | 2022 | 2023 | 2024 | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $56,615 | $68,992 | $74,833 | | Net cash used in investing activities | ($34,458) | ($27,616) | ($22,612) | | Net cash used in financing activities | ($18,276) | ($17,293) | ($45,145) |