Magic Software Enterprises Ltd (MGIC) 2015 Q1 法說會逐字稿

Welcome to the Magic Software Enterprises Limited First Quarter 2015 Results Conference Call. (Operator instructions.) I'd also like to remind you that this call is being recorded. With us on the line today are Mr. Guy Bernstein, CEO, and Mr. Asaf Bernstein, CFO.

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. The Company 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 view or expectations, or otherwise.

On this call today, Management will provide you with the details about Magic's performance in the first quarter of 2015, including certain non-GAAP financial measures. The Company provides non-GAAP financial measures because they believe that they are the most valuable ways to review its core operating results. The Company provided a reconciliation of non-GAAP measures to the comparable GAAP measures in its earning release, which was issued before the market opened this morning, and has been posted on the Company's website at www.magicsoftware.com.

A replay of this call will be available after the call on the IR section of the Company's website.

I would now like to turn the conference over to Mr. Guy Bernstein of Magic Software. Guy, please go ahead.

Good morning, everyone, and thank you for joining us today as we report our first quarter 2015 financial results. I will provide the highlights of our first quarter results, and then turn it over to Asaf, who will dive into the numbers. I will be happy to address any of your questions at the end.

We are pleased with our solid quarter results and increasing operating margins. Revenues in the first quarter reached $40.3 million, with non-GAAP operating income of $6.7 million. Had it not been for the negative impact of foreign exchange rates, this quarter we would have reported record-breaking revenue of $42.8 million and record-breaking non-GAAP operating income of $7.3 million, reflecting an increase of 14% year-over-year.

We continued to enhance our products and enable our customers to benefit from the latest technologies, including in-memory computing, HTML-5, and mobile. We worked to strengthen our relationships with strategic partners, including Oracle, SugarCRM, and salesforce.com, and then had some wins as a result. We continued to advance our existing M&A opportunities, as well as being on the lookout for new ones.

I would now like to turn the call over to Asaf Bernstein, our CFO, to discuss the financial results in more details. Asaf, please?

Thank you, Guy. Today, we will be analyzing our results on a non-GAAP basis, which, as mentioned at the beginning of the call, better conveys the operational state of our business. The financial tables provided in our first quarter 2015, [AR-15], and press release include a (inaudible) reconciliation of non-GAAP measures to the comparable GAAP measures.

As Guy mentioned, our first quarter revenue was $40.3 million compared to $40.9 million for the first quarter last year, and compared to $42.5 million for the first quarter of 2014. In our previous call, we discussed the negative impact of foreign currency exchange rates versus the US dollar on our top and bottom line, as we derive approximately half of our revenues from EMEA and APAC.

Unfortunately, foreign currency eroded further in the first quarter, negatively impacting our revenues by approximately $2.5 million to $3 million compared to the first quarter of [2014], and by approximately $1 million compared to the fourth quarter of 2014, mainly due to the devaluation of the euro, Japanese yen, and New Israeli shekel, which decreased 18%, 16%, and 13% respectively against the US dollar compared to the first quarter of 2014, and 10%, 4%, and 3% respectively compared to the fourth quarter of 2014.

If we eliminate the negative impact of the erosion of foreign exchange rates compared to the first quarter of 2014, revenues for the first quarter would have reached the record-breaking result of $42.9 million, reflecting an increase of 5% year-over-year. This quarter results don't include revenue for our latest acquisition, which was announced in February and closed in April. We look forward to showing its impact next quarter.

Our non-GAAP operating income for the first quarter of 2015 was $6.7 million, which [was] 16.6% operating margin, up 5.7% compared to non-GAAP operating income of $6.4 million, with 15.6% operating margin in the first quarter last year. If we eliminate the negative impact of foreign exchange rate erosion and compared to the first quarter of 2014, non-GAAP operating income for the first quarter would have reached a record-breaking result of $7.3 million, reflecting an increase of 14% year-over-year, with non-GAAP operating margin of 17%.

Financial expenses this quarter totaled approximately $900,000 compared to the financial expenses of $140,000 in Q1 2014. The financial expenses are solely attributed to the impact of devaluation of monetary assets resulting from currency erosion.

Our non-GAAP net income was $5.2 million, or $0.12 per diluted share based on 44.5 million fully diluted shares outstanding compared to non-GAAP net income of $5 million, or $0.12 per diluted share based on 39.9 million fully diluted shares outstanding in the first quarter last year. If we eliminate the negative impact of the erosion of foreign exchange rate compared to the first quarter of 2014, non-GAAP net income for the first quarter would have reached a record-breaking result of $6.7 million, reflecting an increase of 34% year-over-year, or $0.15 per diluted share.

Turning to the balance sheet, we ended the quarter with $88.5 million in total cash and short-term investment. From a cash flow perspective, we generated $9 million from operating activity in the first quarter of 2015, a significant improvement from the $4.5 million in the first quarter of last year.

And our strong financial position, including strong free cash flow, enable us to maintain a dividend policy for our shareholders. Our policy is to return up to 50% of our net income in the form of a dividend. During the first quarter, we distributed on aggregate approximately $3.6 million, or $0.081 per share in accordance with our dividend policy with respect to our 2014 second half results of operations. Our current dividend yield is approximately 3%.

With that, I would like to turn back the call to Guy.

Thank you, Asaf. In summary, we had another solid quarter. However, our results could have been even better had we not been hit by the devaluation in foreign currencies. We are confident in our growth [strategy], remaining focused on profitable growth and enhancing our position with strategic acquisitions.

Today we announced that we expect full year 2015 revenue of approximately $166 million to $173 million. When measured based on 2014 foreign currency exchange rates, this guidance represent full year 2015 revenues of approximately $175 million to $182 million, reflecting management growth expectation of between 7% to 11%.

With that, I will now turn the call over to operator for questions.

Thank you. (Operator instructions.) Tavy Rosner, Barclays.

Hi, yes, thank you for taking my questions. First question perhaps for Asaf, when you look at this quarter's results, you mentioned good underlying results and margins. I was wondering if you could give us some color on what's the driver for the operating margins. Is it the mix of revenues, or decreasing costs? Any color would be helpful.

Yes. As usual, the change in operating margin and our gross margin is dependent on the mix of our revenue. Basically, if you compare our [reports] to the previous quarter, to Q4, then we saw improvement in the level of sales of our [first two] quarters.

The only thing that, of course, also [impressed] our gross margin operating profit is the impact that we get from the erosion of currencies, which mostly are being affected from the euro, the Japanese yen, and the new Israeli shekel, [and as well] we have significant amount of the sales of the (inaudible) product, so [unfortunately for that]. So, this is something that, of course, impairs our gross margin.

And when we look at your guidance, I believe the underlying is 7% to 11% growth, excluding for the FX. I think that's slightly below the color that you guys gave last quarter. I think we were more in the 12%. Has anything changed in your end markets that you're serving?

I think the main reason for that, I mentioned before that we had a lot of business with the telecommunication sector, and we all thought that, after the big merger between AT&T and DirecTV, things would catch up. And apparently, not that they didn't, it came even more slow. So, we are still waiting, and we'd rather be conservative rather than come up with higher numbers. And so, I think for now, we feel more comfortable to go with such numbers until we will see where the sector is going to.

Okay, understood. Thank you. I'll go back to the queue.

Thanks.

Debra Fiakas, Crystal Equity Research.

Thank you for taking my question. I also want to continue the general line of discussion about the anticipated business. Do you anticipate any changes in your mix of business geographically that would also have an impact on the mix of currencies in your revenue?

I cannot say that we anticipate something dramatic. Right now, 50% of the business is coming from the States. The problem is that the remaining 50% is coming from other places, and, as you know, currencies went down dramatically, and we suffered from that. So, for the short-term, I don't think it will change in terms of the mix. Hopefully the currencies will evaluate a bit.

Okay, thank you, and the fact that the AT&T-DirecTV deal didn't go through, that's not going to reduce your presence in the US market?

No. I think what you see is the low run rate right now. We expected it to pick up before, because we had all the signs at the beginning. Let's say, at the mid-last year we had all the signs that things will pick up, and unfortunately they didn't. So, what you see is kind of the bottom of it.

All right, very good. And then, just to help out a bit with the modeling, could you maybe give us a little bit of a description in the mix of business, software versus maintenance and technical support, or consulting services?

Basically this doesn't change, or didn't change over the last eight quarters. Currently, 70% of our revenues are coming from software services, the professional services that we provide, 30% are coming from sales of software products and maintenance and support. So, this is something that is pretty much stayed over the last three quarters.

Okay. And then, just another sort of housekeeping question, it sounded like you'd had a very good quarter in terms of generating operating cash, and I wondered if perhaps you could characterize the sources of the operating cash beyond the net income. Was it mostly working capital contributions, or is there something else in that operating cash flow number that is of interest?

I think in the operating cash flow, what you see usually during the first half, we collect the maintenance funds. So, usually in terms of cash flow, the first half is better when you compare it to the net income that we generate.

Okay, very good. Thank you, and I'll go back into the queue.

Okay, thank you.

Bhavan Suri, William Blair.

Hey, guys, this is actually Alper Tuken in for Bhavan. I just have two quick questions. I know in the press release you mentioned the strong license sales across all of your regions. I was just wondering how this compared to kind of the first quarter last year, just in general, about the license activity that you guys saw.

If you exclude [the] one specific area in Japan where last year we had a tremendous good start for the year because there was some changes in the tax legislation, and also there was an end-of-life for a certain Microsoft version that brought forward a transaction that would have come normally due in the year, then we saw improvement in Europe and in the US, and all of the other areas that we operate in.

Okay, that's great. And I know you talked about a little bit of slowdown with AT&T and DirecTV, but maybe I just wanted to get your thoughts on what the pipeline for that could potentially look like in the back half of this year, if you can maybe see an acceleration of activity there.

They are talking all the time about acceleration. The problem is that they talked about it, like, six months ago, and we were quite confident that it will come, and it didn't. So, they still talk about the acceleration. They're talking about many projects that they should launch. But, for now, we are still running on the, let's say, bare minimum of what we saw from them in the last probably three, four years. So, it's not going down, which is a good news, but it's not picking up yet as we expected.

Okay. And then, just one last real quick one. I notice the selling, marketing, and general and administrative expenses as a percentage of revenue are the lowest they've ever been. Was this mainly due to currency, or is this kind of a structural change in how you guys are looking at those expenses?

I would say mostly currencies, but we did make some changes in the structure of the business.

Okay. Okay, thank you. That's all for me. Thank you, guys.

By the way, [Bhavan], what you can see is that, no matter if the -- what impacts is [beyond the] revenue, usually we are kind of ahead in terms of the expenses, and we do what's needed in order to keep good margins.

Okay. Thank you.

Kevin Dede, H.C. Wainwright.

Thank you, (inaudible). Guy, could you give us a little insight on the -- I mean, and I know you mentioned the decent pipeline on the acquisition side, but can you give us a little more color on the one that you've done, and the pipeline? Now, you said that this one closed in April. Could you give us any sort of framework on how you expect it to contribute, and how you expect to take its services that [that company] delivers to other geographies? And then, yes, detail on the pipeline.

Okay. So, with relation to the acquisition that we just closed, we are talking about high-level professionals that are dealing mainly with mainframes. As you know, we have the AppBuilder platform that we market, and this company is heavily based on the Israeli market. What we intend to do is basically to take it to our broad customers, because, as you know, AppBuilder is [selling most] everything outside Israel. So, we intend to use them, and of course, to grow the business.

We already signed a nice deal (inaudible) that we cannot [enhance] anything because, when you work with the giants, just in order to get the permission to announce anything, you need to wait probably a few years. But, we already see some good sign from this acquisition, which is good.

Okay. I apologize for interrupting you, Guy, but you mentioned the platform. Could you just -- apparently it just got garbled a little bit over here. I was just wondering what platform you were referring to.

To AppBuilder.

I'm sorry?

AppBuilder.

Okay. All right. So, the idea is to extend that?

Yes.

Okay. I'm sorry, go ahead.

Okay. In terms of the partner, we have currently three opportunities on the table, too. We're talking about technology companies. I don't know to say yet what are the chances in terms of closing. I think with one of them we have agreed on prices, but I think the structure is more difficult, shareholders [and so].

With the other one, we have a meeting to discuss pricing. If we agree on pricing with the second one, then of course it will go faster, because then it's a private company, and it is here.

And we have a third one, another consulting company in the States that we are checking right now, and we'll see about it. Again, I'm trying to be cautious with regard to timing, because with the last one we thought we would close it, like, the end of last year and, because of antitrust, we had to wait.

Right, right. So, that's all solved, the antitrust issue on the Israeli company is solved, okay. So, can you talk a little about the pricing environment and valuations? Are you finding that some of these companies are willing to work with you closely, just given the scale opportunity, or do you still see the M&A environment as pretty hot, and a lot of these are closely contested?

I would say that you need to pinpoint the targets the minute they are out there in the market. We have difficulties to compete because you see a lot of private equity is coming in with enormous amount of money, paying huge valuations, which usually we don't pay.

So, it's a struggle today when you talk about acquisitions. Not easy because, the minute they have a banker, our chances are going down because of the competition with private equities. Of course, if we talk about something which is strategic for us, then we're willing to pay more, and we get a good fight even to the private equity fund. But, we'll see about it.

Right, okay. So, the mainframe deal, did you see that one as being more strategic?

Yes, definitely it's like a one-plus-one equals three for us.

Okay. Can you give us a ballpark on your consultant headcount?

In total?

Yes.

Well, that's a lot. I assume today probably we have, like, 700.

Okay. I was just wondering if you could talk to that level at the end of the quarter actually post-acquisition versus prior.

In this acquisition, we added, like, 50, 60 consultants. Again, and I think it's important for us to emphasize, our consultants are working only if they generate revenues. The minute we see that they don't, we don't hold any [badge].

Right. Okay. Could you talk a little bit about -- I mean, I suppose this is a little bit better for Asaf, but could you talk a little bit about how you might try to hedge some of the currency fluctuations?

It's a problem, because, for the long-term, I think we have kind of natural hedge between the markets. So, every now and then, you see that the euro goes up or down, and you see that the yen suddenly is picking up. I don't think we can protect our revenues, definitely not the revenues, because it will probably cost us a fortune.

We are trying here and there to catch up the [picks] in order to protect our bottom line. But, here, for example, you have receivables that are based on local currency, it's very hard to protect it. So, you see some fluctuation. I think in the long-term, it proves that the natural hedge is working.

Okay. Can you talk a little bit about how you see some of the larger software houses, IBM, Salesforce, Oracle, SAP, and how you see them working on their development activities to more closely work together? I think the big question in my mind is always, I mean, I know this is sort of a long-term vision, probably, but I just see more of those companies working more closely together to provide a higher level of their own integrating, making it a little bit more difficult for some of the smaller consultancies to offer services. And I'm just -- I guess I've got to ask that question every quarter. So, could you just give us an update on your view on that?

Yes. I can relate to two of them. I can relate to Salesforce and to SugarCRM. As for Salesforce, [you know] we work quite independently with their customers. Every now and then, we get some approach from them talking about some partnerships, but till now just discussions. I didn't see anything coming out of it. With SugarCRM, we started to discuss a re-partnership, and let's see how it develops. It looks like they are serious.

I see. Okay. I guess just from a software integration perspective, and looking at how those software platforms integrate with the other large ERP systems, could you just talk a little bit about how you see that developing?

We need to divide it between the type of customers you are dealing with, because if you talk about the big customers that, let's say, are using [RPU-E] for SAP, usually they will follow SAP with their integration platform no matter how costly it is. When you go to the mid-level, then pricing become important, pricing and functionality, and this is where we play.

So, some of them are going after the cost. Some of them are going after the kind of plug-and-play, the fact that you can make it work faster. Some of them are looking after the vision, to see that you can support their cloud capabilities. It varies between the customers.

So, I guess in general I'm wondering if you've seen that dynamic change at all. Do you see Salesforce and SAP, Oracle, pushing down to some of the smaller companies, or do you think it's still too closely tied to pricing and functionality?

I think all of them are trying to push down. I think the pricing is barrier for them.

Okay. Can you talk a little bit about the development that you guys are doing in-house? I know mobile's a big push for you. We haven't seen that many new announcements. But, I'm wondering where you have your R&D team focused, and what you think the most exciting developments that you might have to come out and we should be looking for.

I still think that the mobile part is the most exciting part. The reason you don't see announcement is because most of the deals are rather small. So, we don't see any point in announcing on that. But, there is definitely -- most of the interest is around mobile.

Okay. So, from a software development perspective, is that still your primary focus?

Definitely.

Okay. Can you talk a little bit about some of the things that you're working on, and how you're putting your R&D dollars to work, and how you think you might be able to differentiate your platform from some of the other companies? Because there's definitely a lot of focus on mobile.

I think in general we are concentrating on the two mainstream platforms, (inaudible). The idea is to allow developers to develop with the Magic platform in a totally agnostic way to the deployment, so they can choose how to deploy it later on. I think we keep on the same methodologies we had in the original standard world of development. We stick with the mobile, as well.

And then, can you just talk about your access to R&D talent? Are you trying to add more people to build the ranks there? And if so, where are you trying to build your R&D effort?

I think here and there on a minimal scale. We do hire more experts, especially when you talk about [some] niche expertise. But, all in all, the team here is quite experienced, and everything is kind of hooked up to the original platform. Therefore, even if I bring, like, the newest brain in town, he will not be effective unless someone will work with him on the platform.

Right, right. Okay. How do you see your 700 headcount in relation to the $156 million and $173 million guidance that you offered? Are you thinking that you'll be able to hit that guidance with the headcount that you have? Do you think you're going to have to be able to fold in one or maybe three of the acquisitions that you've talked to?

No. Currently the acquisitions that we talked about are not included. And yes, we definitely think that we can hit the guidance with the existing headcount we have.

Great. Okay. Well, thank you very much for taking all my questions.

Thank you.

(Operator instructions.) Nehal Chokshi, Maxim Group.

Yes, thank you for taking my question. For the guidance of 7% to 11% year-over-year growth on a constant currency basis, could you provide some color as far as how much of a contribution the existing acquisitions that you just made will make to that, as well as if the future potential acquisitions are embedded in that number, as well?

Well, I said that the future acquisitions are not included in this number, and the current one is rather small. So, in terms of percentages, it's like less than -- [further than] 5%.

Less than 5%, okay. And did you provide how much you guys paid for this acquisition here?

No, we didn't.

Did not, okay.

But it's a good buy.

Okay. And then, you mentioned that this is a strategic acquisition. Could you explain why it is so strategic, especially given that it is specializing in mainframe environments when, from my understanding, mainframe environment is something that has been in decline?

Okay, so let's talk about the mainframe market. I don't know if you are aware, but the mainframe market, everybody's talking about the fact that it's declining. But, I must say that every year we are doing better and better on our mainframe platform.

The thing with the mainframe is that, when you're working high scalability in many big organizations, it's the only machines that can support such huge transaction. And therefore, people tend to keep this machine running. And as you know, to find mainframe consultancies is rather hard. Here we took a company with mainframe consultant. All of them are young people. Usually when you talk about mainframe guys, you see people like between 50s to 60s. Here we're talking about young people. And we know how to hire and train more and more people around mainframe.

And the reason usually depends. We see it from our customers. Usually when they look for people, it's quite hard for them to find people. It's either quite expensive, or just how to find the right people. And we definitely see here the opportunity of bringing our customers some fresh guys, mainframe experts, is how we see it.

Okay, thank you very much for that explanation.

Thank you.

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

Yes. So, thank you all for joining our call again, and we'll be, of course, happy to [come up with news] in the [near] future, and talk to you soon.

Thank you. This concludes the Magic Software Enterprises Limited First Quarter 2015 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.