Magic Software Enterprises(US:MGIC)2022-05-12 18:26Introduction Magic Software Enterprises Ltd. offers global software services, IT outsourcing, and proprietary low-code platforms for application development and integration across various industries Company Overview Magic Software Enterprises Ltd. offers global software services, IT outsourcing, and proprietary low-code platforms for application development and integration across various industries - The company operates in four main business areas: (i) software and IT outsourcing services, (ii) application development and integration platforms, (iii) vertical software solutions, and (iv) cloud-based digital transformation services21 - Key proprietary platforms include Magic xpa and AppBuilder for low-code application development, and Magic xpi for application integration26 - The company offers specialized vertical software solutions such as Clicks™ for healthcare, Leap™ for telecom billing, and Hermes for air cargo management2428 - As of the report date, the company has approximately 3,677 employees and operates through a network of over 3,000 independent software vendors (ISVs) and partners in about 50 countries25 Forward-Looking Statements This section highlights that the annual report contains forward-looking statements subject to various risks, including M&A integration, competition, cybersecurity, and geopolitical instability in Israel - Key risks highlighted include challenges in integrating acquired companies, lengthy and complex sales cycles, competition, cybersecurity breaches, the impact of the COVID-19 pandemic, and risks associated with global operations and the company's location in Israel37 Key Information The company identifies significant risks across its business, industry, operations, and location Risk Factors The company faces significant risks across its business, industry, and operations, including M&A integration, product dependence, intense competition, and geopolitical instability in Israel Risks Related to Our Business and Our Industry The company faces business and industry risks from M&A integration, product dependence, intense competition, customer concentration, and geopolitical conflicts - The company's M&A growth strategy involves significant risks related to integrating acquired businesses, operations, and employees56 - A significant portion of revenues comes from a limited number of core product families (e.g., Magic xpa, Magic xpi, AppBuilder) and vertical solutions (e.g., Clicks, Leap, Hermes)6667 - The company faces intense competition from multinational IT providers, offshore firms, and in-house IT departments83 - The two largest clients accounted for 21.2% of revenues in 2021, and the five largest accounted for 27.5%, indicating significant customer concentration risk77 - The ongoing military conflict between Russia and Ukraine poses geopolitical and economic risks, as the company employs approximately 220 people in Russia and 104 in Ukraine89 - The company relies on a combination of contractual provisions and intellectual property law, rather than patents, to protect its proprietary technology122 Risks Related to Our Ordinary Shares Risks related to ordinary shares include dual listing price variations, limited liquidity, foreign private issuer status, and significant influence from a controlling shareholder - The company's ordinary shares are dual-listed on NASDAQ (MGIC) and the Tel Aviv Stock Exchange, which may result in price variations due to different currencies, time zones, and trading days134 - As a foreign private issuer, the company is exempt from certain SEC rules, including proxy solicitations and Section 16 "short-swing" profit recovery provisions, resulting in less public disclosure compared to U.S. domestic companies137 - As of April 1, 2022, controlling shareholder Formula Systems (1985) Ltd. beneficially owns approximately 45.58% of outstanding ordinary shares, giving it controlling influence over matters requiring shareholder approval139 Risks Related to Our Location in Israel The company's Israeli location exposes it to regional political and military instability, potential operational disruptions, and specific legal provisions affecting acquisitions - The company's principal executive offices and R&D facilities are located in Israel, making it susceptible to political, economic, and military instability in the region145 - Many Israeli employees are obligated to perform annual military reserve duty, and their absence during a military conflict could disrupt operations148 - Provisions of Israeli corporate law regarding mergers and tender offers may delay, prevent, or complicate a potential acquisition of the company151 Information on the Company This section provides an overview of the company's history, business operations, organizational structure, and property, plants, and equipment History and Development of the Company Founded in 1983, the company's shares are dual-listed, and it pursues growth through strategic acquisitions, with recent capital expenditures noted - The company's shares are dual-listed on the NASDAQ Global Select Market (since 2011) and the Tel Aviv Stock Exchange (since 2000)153 - Recent acquisitions as part of its M&A strategy include EnableIT, Menarva, and Soft IT in 2021, and Aptonet and Stockell in 2020159160161162163 Capital Expenditures | Year | Capital Expenditures (in millions) | | :--- | :--- | | 2019 | $1.4 | | 2020 | $2.8 | | 2021 | $1.4 | Business Overview The company offers software platforms, vertical solutions, and IT services, leveraging strategic partnerships and industry trends like low-code and cloud for growth - The business model is based on three pillars: software technology platforms, vertical software packages, and professional software/IT services166173175 - The company's low-code platforms (Magic xpa, AppBuilder, SmartUX) and integration platform (Magic xpi) are designed to reduce development time and cost for enterprise applications171172 - Strategic partnerships include Oracle (Platinum Partner), SAP (Gold Partner), Salesforce (Premier ISV Partner), and Microsoft (Gold Competency)179180181182 - The company's growth strategy includes expanding within its existing customer base, capitalizing on trends like mobile and cloud, attracting new customers with new offerings, and pursuing complementary acquisitions254 Revenue by Type (2019-2021) | Revenue Type | 2021 (in thousands) | 2020 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | Software sales | $30,934 | $24,272 | $28,084 | | Maintenance and technical support | $36,149 | $33,181 | $30,996 | | Consulting services | $413,242 | $313,741 | $266,550 | | Total revenues | $480,325 | $371,194 | $325,630 | Revenue by Geography (2019-2021) | Geography | 2021 (in thousands) | 2020 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | United States | $254,342 | $177,882 | $158,095 | | Israel | $180,462 | $149,094 | $124,523 | | Europe | $30,085 | $26,947 | $25,788 | | Japan | $11,443 | $12,643 | $12,499 | | Other | $3,993 | $4,628 | $4,725 | | Total revenues | $480,325 | $371,194 | $325,630 | Organizational Structure This section details the company's global organizational structure, listing numerous wholly-owned and majority-owned subsidiaries across key regions - The company operates through a complex structure of numerous subsidiaries across the globe, with significant operations in the US, Israel, Japan, and Europe297299 Property, Plants and Equipment The company's headquarters and global subsidiaries operate from leased facilities, with total annual rent for all locations reaching $5.4 million in 2021 - The company's principal executive office is a leased facility in Or Yehuda, Israel. The lease expires in June 2033 with options to extend300 - The aggregate annual rent for all leased office facilities worldwide was $5.4 million for the year ended December 31, 2021301 Operating and Financial Review and Prospects This section provides a comprehensive analysis of the company's financial performance, liquidity, capital resources, research and development efforts, and critical accounting policies Operating Results In 2021, total revenues grew 29% to $480.3 million, driven by professional services, though gross margin declined due to revenue mix shift, while operating and net income increased Financial Performance Summary (2020 vs. 2021) | Metric | 2021 (in millions) | 2020 (in millions) | Change | | :--- | :--- | :--- | :--- | | Total Revenues | $480.3 | $371.2 | +29% | | Gross Profit | $133.0 | $109.6 | +21% | | Gross Margin | 27.7% | 29.5% | -1.8 p.p. | | Operating Income | $51.2 | $40.6 | +26% | | Net Income (to Shareholders) | $29.3 | $25.2 | +16% | - The revenue mix shifted in 2021, with professional services accounting for 81% of total revenue, up from 77% in 2020. This shift contributed to the decline in overall gross margin319 - Despite the revenue mix shift, the gross profit mix remained relatively stable, with software solutions contributing 45% of gross profit in 2021 (vs. 47% in 2020) and professional services contributing 55% (vs. 53% in 2020)320 Research & Development Costs (Net) | Year | Gross R&D Costs (in thousands) | Capitalized Costs (in thousands) | Net R&D Expenses (in thousands) | | :--- | :--- | :--- | :--- | | 2021 | $12,188 | $(3,193) | $8,995 | | 2020 | $12,091 | $(3,302) | $8,789 | | 2019 | $12,382 | $(4,143) | $8,239 | Liquidity and Capital Resources The company maintains strong liquidity with $94.8 million in cash and $138.6 million in net working capital, financing operations through cash flow, investments, and debt, while adhering to a dividend policy Liquidity Position (as of Dec 31) | Metric | 2021 (in millions) | 2020 (in millions) | | :--- | :--- | :--- | | Cash, cash equivalents & marketable securities | $94.8 | $89.7 | | Net working capital | $138.6 | $126.4 | | Long-term debt | $20.2 | $13.4 | Cash Flow Summary (2019-2021) | Cash Flow Activity | 2021 (in thousands) | 2020 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | Net cash from operating activities | $37,810 | $52,296 | $45,948 | | Net cash used in investing activities | $(16,854) | $(9,604) | $(15,440) | | Net cash used in financing activities | $(20,735) | $(39,647) | $(36,980) | - The decrease in operating cash flow in 2021 was primarily driven by a $27.4 million increase in trade receivables364 - The company has a dividend policy to distribute up to 75% of its annual net income attributable to shareholders, distributed on a semi-annual basis374 Research and Development The company prioritizes R&D, investing $12.2 million in 2021, with a team of 228 employees primarily based in Israel, India, and Russia R&D Investment (Gross) | Year | R&D Investment (in millions) | | :--- | :--- | | 2019 | $12.4 | | 2020 | $12.1 | | 2021 | $12.2 | - As of December 31, 2021, the R&D team consisted of 228 employees, with the majority located in Israel (87), India (114), and Russia (21)379 Critical Accounting Policies and Estimations This section details critical accounting policies, including revenue recognition, business combinations, goodwill impairment testing, and the capitalization and amortization of research and development costs - Revenue Recognition (ASC 606): The company recognizes revenue when control of goods or services is transferred. Software licenses are typically recognized at a point in time, while services and customized solutions are recognized over time382385 - Business Combinations (ASC 805): The company allocates the purchase price of acquisitions to the fair value of assets and liabilities, requiring significant estimates for intangible assets like customer relationships and technology398399 - Goodwill: Goodwill is tested for impairment annually at the reporting unit level using a discounted cash flow model. No impairment losses were identified in 2019, 2020, or 2021402405406 - Research and Development Costs: R&D costs are expensed until technological feasibility is established. Subsequent costs are capitalized and amortized over the product's estimated useful life (typically 5 years)392395 Directors, Senior Management and Employees This section outlines the company's leadership, compensation practices, board structure, employee demographics, and share ownership Directors and Senior Management This section lists the company's directors and executive officers, including key figures like CEO Guy Bernstein and CFO Asaf Berenstin, noting the board's composition with external directors - Guy Bernstein is the Chief Executive Officer and a Director. He also serves as the CEO of the parent company, Formula Systems430433 - Asaf Berenstin serves as the Chief Financial Officer for both Magic Software and Formula Systems430438 Compensation Total compensation for directors and executive officers was approximately $3.45 million in 2021, with a detailed breakdown provided for the five most highly compensated officers - Total compensation for all 13 directors and executive officers as a group was $3,361,141 in salaries/bonuses and $87,971 in pension/benefits for the year ended December 31, 2021447 2021 Summary Compensation Table (Top 5 Officers) | Name and Position | Salary (in USD) | Bonus (in USD) | Equity Based Compensation (in USD) | All Other Compensation (in USD) | Total (in USD) | | :--- | :--- | :--- | :--- | :--- | :--- | | Arik Kilman, Chairman, Software Group | $278,620 | $416,720 | $956,000 | - | $1,651,340 | | Yakov Tsaroya, President, Coretech | $400,000 | $1,189,000 | - | $54,000 | $1,643,000 | | Arik Faingold, President, Integration Solutions | $669,000 | $196,820 | - | - | $865,820 | | Yuval Baruch, CEO of Hermes Logistics | $275,525 | $176,300 | - | - | $323,925 | | Hanan Shahaf, CEO of Roshtov Software | $317,520 | - | - | $8,100 | $325,620 | Board Practices The company's board, comprising five directors including two external directors, operates with Audit and Compensation Committees, adhering to Israeli law for governance and related-party transaction approvals - The board of directors is currently composed of five members, including two external directors as required by Israeli Companies Law456459 - The company has an Audit Committee and a Compensation Committee, both comprised of independent directors, to oversee financial reporting, internal controls, and executive compensation470472 - Transactions with controlling shareholders or office holders require a stringent approval process involving the audit/compensation committee, the board of directors, and often a special majority of non-interested shareholders479480 Employees The company's workforce grew to 3,677 employees in 2021, primarily in North America and Israel, with most in technical support and consulting roles, emphasizing retention strategies Employees by Geographic Location | Region | 2021 (Number of Employees) | 2020 (Number of Employees) | 2019 (Number of Employees) | | :--- | :--- | :--- | :--- | | Israel | 1,268 | 1,184 | 1,133 | | Asia | 190 | 204 | 186 | | North America | 1,709 | 1,513 | 1,194 | | South Africa | 12 | 12 | 14 | | Europe | 498 | 126 | 115 | | Total | 3,677 | 3,039 | 2,642 | Employees by Activity | Activity | 2021 (Number of Employees) | 2020 (Number of Employees) | 2019 (Number of Employees) | | :--- | :--- | :--- | :--- | | Technical support and consulting | 3,137 | 2,506 | 2,126 | | Research and development | 228 | 233 | 212 | | Marketing and sales | 166 | 161 | 158 | | Operations and administrations | 146 | 139 | 146 | | Total | 3,677 | 3,039 | 2,642 | Share Ownership As of April 1, 2022, directors and executive officers held 260,775 ordinary shares, with equity awards granted under the 2007 Incentive Compensation Plan, extended to 2027 - As of April 1, 2022, directors and executive officers as a group (13 persons) beneficially owned 260,775 Ordinary Shares505514 - The company's 2007 Incentive Compensation Plan allows for equity grants to employees, directors, and consultants and is set to terminate in August 2027506508 Major Shareholders and Related Party Transactions This section details the company's major shareholders and outlines its policies and procedures for related party transactions Major Shareholders Formula Systems (1985) Ltd. is the controlling shareholder with 45.58% ownership, alongside other major institutional shareholders, all possessing equal voting rights - Formula Systems (1985) Ltd. is the controlling shareholder, holding 45.58% of outstanding shares as of April 1, 2022. Formula Systems is controlled by Asseco Poland S.A516 Major Shareholders (as of Dec 31, 2021) | Shareholder | Percentage of Ownership | | :--- | :--- | | Formula Systems (1985) Ltd. | 45.59% | | Harel Insurance | 9.37% | | Clal Insurance Enterprises Holdings Ltd. | 7.51% | Financial Information This section provides an overview of the company's consolidated financial statements, legal proceedings, and dividend policy Consolidated Statements and Other Financial Information This section details a $1.6 million arbitration ruling against the company in 2021 and outlines its dividend policy to distribute up to 75% of annual net income - In July 2021, an arbitrator ruled that the company must pay $1.6 million in damages related to a lawsuit filed in 2016 by an Israeli software company concerning alleged copyright infringement warnings528 - The company's dividend policy is to distribute up to 75% of its annual net income attributable to shareholders, subject to board discretion and applicable law529 The Offer and Listing This section describes the markets where the company's ordinary shares are traded Markets The company's ordinary shares are dual-listed and traded on the NASDAQ Global Select Market and the Tel Aviv Stock Exchange - The company's ordinary shares are listed on the NASDAQ Global Select Market (MGIC) and the Tel Aviv Stock Exchange (TASE)533535 Additional Information This section provides additional details, including the company's taxation policies and their implications for shareholders Taxation This section outlines Israeli and U.S. tax implications for shareholders, including corporate tax rates, dividend withholding, capital gains, and the company's non-PFIC status for 2021 - The general corporate tax rate in Israel is 23%, but the company benefits from reduced rates under the Law for the Encouragement of Capital Investments, with some income qualifying for rates as low as 12% or 6%552564567 - For non-Israeli resident shareholders, dividends are generally subject to a 25% withholding tax, which may be reduced by an applicable tax treaty. Dividends from income under preferred tax regimes may be subject to lower rates (e.g., 15% or 20%)581 - For U.S. Holders, dividends are generally taxable as ordinary income but may qualify for lower long-term capital gain rates if the company is considered a "qualified foreign corporation"588591 - The company believes it was not a Passive Foreign Investment Company (PFIC) for the 2021 taxable year, but its status is determined annually and cannot be guaranteed for future years595 Quantitative and Qualitative Disclosures about Market Risks This section details the company's exposure to market risks, primarily from interest rate and foreign currency fluctuations, and its strategies for mitigation Market Risk Analysis The company faces market risks primarily from interest rate fluctuations and significant foreign currency exposure, particularly to the NIS, Euro, JPY, and GBP, which it mitigates with hedging - The company's main market risks are interest rate fluctuations affecting its investment portfolio and foreign currency exchange risk612 - The company's earnings are predominantly affected by fluctuations of the U.S. dollar against the New Israeli Shekel (NIS), Euro, Japanese Yen, and British Pound616 - A hypothetical 10% increase in the value of the NIS relative to the U.S. dollar in 2021 would have increased operating income by $2.7 million, while a 10% decrease would have reduced it by $2.2 million618 Controls and Procedures This section details management's assessment of the company's disclosure controls and internal control over financial reporting Management's Assessment Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2021, excluding recently acquired businesses - Management concluded that as of December 31, 2021, the company's disclosure controls and procedures, as well as its internal control over financial reporting, were effective624626 - The assessment of internal controls did not include companies acquired in 2021 (Menarva, Soft IT, and Enable IT), which represented 6% of revenues for the year627 Corporate Governance and Other Information This section covers principal accountant fees and the company's corporate governance practices as a foreign private issuer Principal Accountant Fees and Services This section details the fees paid to the principal independent accounting firm, Kost Forer Gabbay & Kasierer, totaling $468,000 in 2021, with all services pre-approved Accountant Fees (2020-2021) | Services Rendered | 2021 (in USD) | 2020 (in USD) | | :--- | :--- | :--- | | Audit | $376,000 | $365,000 | | Tax and other | $92,000 | $92,000 | | Total | $468,000 | $457,000 | Corporate Governance As a foreign private issuer, the company adheres to Israeli home country corporate governance practices, diverging from certain NASDAQ rules regarding independent directors and shareholder approvals - The company follows Israeli home country practices in lieu of certain NASDAQ rules, such as not requiring a majority of independent directors on the board and not requiring regularly scheduled meetings of only independent directors639642 Financial Statements This section includes the independent auditor's report and the company's consolidated financial statements Report of Independent Registered Public Accounting Firm The independent auditor issued unqualified opinions on financial statements and internal controls, identifying goodwill valuation as a Critical Audit Matter due to complex estimations - The independent auditor issued an unqualified opinion on both the consolidated financial statements and the effectiveness of internal control over financial reporting653664 - A Critical Audit Matter (CAM) was identified related to the Valuation of Goodwill. The audit of this area was considered complex and highly judgmental due to the significant estimations required for the discounted cash flow analysis, including projections of future revenues, operating margins, and discount rates659661 Consolidated Financial Statements This section presents the company's detailed consolidated financial statements for 2021, prepared under U.S. GAAP, including balance sheets, income statements, and cash flow statements Consolidated Balance Sheet Highlights (As of Dec 31, 2021) | Account | Amount (in thousands) | | :--- | :--- | | Total Assets | $492,045 | | Cash and cash equivalents | $88,090 | | Goodwill | $146,803 | | Total Liabilities | $185,945 | | Total Equity | $275,668 | Consolidated Statement of Income Highlights (Year Ended Dec 31, 2021) | Account | Amount (in thousands) | | :--- | :--- | | Total Revenues | $480,325 | | Gross Profit | $132,994 | | Operating Income | $51,235 | | Net Income | $34,904 | | Net Income (to Magic Shareholders) | $29,332 | | Basic and Diluted EPS | $0.52 |