Magic Software Enterprises Ltd (MGIC) 2015 Q3 法說會逐字稿

Welcome to the Magic Software Enterprises Limited Third 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; Mr. Asaf Berenstin, CFO; Mr. Amit Birk, VP M&A and General Counsel; and Mr. Itai Galmor, VP Global Marketing and Business Development.

I will now hand the conference over to Mr. Amit Birk of Magic Software. Please begin.

Thank you, and good morning, everyone. Our quarterly earnings release was issued before the market opened this morning, and is available on the Company's website at www.magicsoftware.com.

Before we start, I would 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 contents 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, we will provide you with details about Magic's performance in the third quarter and first nine months of 2015, including certain non-GAAP financial measures. We provide the non-GAAP financial measures because we believe that they are the most valuable way to review our core operating results. We have provided a reconciliation of non-GAAP measures to their comparable GAAP measures in our earnings release.

A replay of this call will be available after the call on the Investor Relations section of the Company's website. I will now turn the call over to Guy.

Good morning, everyone. And thank you for joining us today as we report our financial results for the third quarter and first nine months of 2015. I will review the highlights from our third quarter, and then turn it over to Asaf who will provide more detailed financial information. I will be happy to address any of your questions at the end.

We are pleased with our third quarter performance, including record-breaking revenues of $45.3 million, reflecting 13% year-over-year growth, and double-digit growth in non-GAAP net income. Non-GAAP net income was $5.7 million, a year-over-year increase of 14%. And our earnings per share of $0.13 reflects an increase of 80% year over year.

We are continuing to see a solid demand for our software and professional services from all regions, demonstrating the relevance of our enterprise mobility, cloud integration, and big data solutions as companies move forward with digital transformation.

Our focus on operational discipline while enriching our offerings and enlarging our customer base has enabled us to maintain non-GAAP operating margins of over 15% year to date, despite foreign currency devaluation, and a change in revenue mix.

We are confident with our projections and are maintaining our revenue guidance of $166 million to $173 million for the full year 2015, reflecting 7% to 11% growth rate on a constant currency basis.

I would now like to turn the call over to Asaf Berenstin, our Chief Financial Officer, to discuss the financial results in more detail. Asaf, lead the way.

Thank you, Guy. Good morning, everyone and happy Veteran's Day to our American listeners. Today we will be analyzing our results on a non-GAAP and constant currency basis, which as mentioned at the beginning of the call, provide valuable supplemental information regarding our results of operation, consistent with how we evaluate our performance.

As Guy mentioned, we produced record-breaking third quarter revenues, growing 13% to $45.3 million, compared to $40.2 million for the third quarter last year, and compared to $42.5 million in the second quarter of 2015.

While we are pleased with these record-breaking numbers, had it not been for the negative impact of the erosion in foreign exchange rate, we would have shown quarterly revenues of $47.8 million, reflecting a 19% increase year over year. The foreign currency erosion in the third quarter negatively impacted our revenues by $2.5 million, compared to the third quarter of 2014, mainly due to the devaluation of the New Israeli shekel, the euro, and Japanese yen, which decreased 9%, 16% and 15% effectively, compared to the third quarter of 2014.

Turning now to profitability, our non-GAAP gross profit for the third quarter of 2015 was $16.7 million, up 3% compared to the non-GAAP gross profit of $16.3 million in the third quarter last year. Non-GAAP gross margin was 36.8%, down from 40.4% for the third quarter of last year.

On a constant currency basis, non-GAAP gross margin for the third quarter would have reached 37.9%. The fact that over 50% of our software license and maintenance and support revenues, which carry gross margins of over 85% are generating in currency other than the US dollar, means that the currency erosion negatively influenced our gross margin by 1%, and our gross profit by $1.4 million compared to the third quarter last year.

Non-GAAP operating income for the third quarter of 2015 was $6.6 million, up 3% compared to non-GAAP operating income of $6.4 million in the third quarter last year. Non-GAAP operating margin decreased to 14.6%, compared to 16% in the same period last year.

On a constant currency basis, non-GAAP operating income for the third quarter would have reached $7.1 million, reflecting an increase of 10% year over year, with non-GAAP operating margin of 14.8%.

Financial income this quarter totaled approximately $389,000, compared to financial expenses of $486,000 in the third quarter of 2014.

Our non-GAAP net income was $5.7 million, or $0.13 per diluted share, based on 44.5 million fully-diluted shares outstanding, compared to non-GAAP net income of $5 million, or $0.11 per diluted share, based on 45.5 fully-diluted shares outstanding in the third quarter last year.

On a constant currency basis, non-GAAP net income for the third quarter would have reached $6.2 million, or $0.14 per diluted share, reflecting an increase of 23% year over year.

Turning to the balance sheet, we ended the quarter with approximately $81 million in total cash and short-term investments, generating approximately $50 million from operating activities during the first nine months, a significant improvement from the $8.8 million in the same period last year.

Our strong financial position, including strong free cash flow, enabled us to maintain the dividend policy for our shareholders. Our policy is to return up to 50% of our net income in the form of a dividend. During this quarter we distributed the dividend for the first half of 2015 of approximately $4.2 million, or $0.095 per share, in accordance with our dividend policy. From the beginning of the year we have distributed approximately $7.8 million or $0.176 per share. Our common dividend yield is approximately 3.2%.

With that I will turn the call back to Guy for closing comments.

Thank you, Asaf. In summary, we are pleased with our record-breaking revenue, and double-digit profitability. Revenues for the first nine months stand at $128 million. And with our fourth quarter historically being our best quarter, we are on track to meet our guidance of $166 million to $173 million, reflecting a 7% to 11% growth rate on a constant currency basis.

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

(Operator Instructions) Bhavan Suri, William Blair

Hey, guys. Nice job and good to see the solid growth in the top line. I guess, Guy, just starting at the top, maybe a little color what drove the beat on the top line. And sort of was it product? Was it services? And then was it the mobility product or the data integration product? How should we think about what drove that upside?

I think, first of all, because the mix has changed a bit this quarter, then you can see that a big portion of it is coming from the services. I think along with the migration over to mobility and the new world, you see a lot of integration around it. And therefore it's kind of going without saying that you have a lot of services around it. Because in most of the projects end users do not know how to move forward with it. So we need to provide them with the whole solution.

Got it, got it. And then when you think about sort of-- and maybe this is one for Asaf. But when you think about the beat and then maintaining guidance, is that just conservatism on your part, or is there something specific, a project that ended or something that might end in Q4 that sort of gives you some pause, and sort of you didn't raise full-year guidance because of that?

No. I think that the run rate of the Company is pretty clear and sustainable. So I don't think that there is anything that might end or, let's say, come as a big surprise to us. The backlog during this period for the maintenance support is closed. Most of the professional services projects are already into the next year. So I don't think that there is an issue with that.

I think we would have--

Go ahead, Guy, yes?

I think with-- the thing is that if you look at this quarter on a straight-line basis, you end up, Q4 then we should be at the top part of the range. But you know, we keep the range because we suffered [some] surprises before, especially from the currency exchange. So we have been cautious here.

Great. And then two quick from me just on the business. Obviously Microsoft pushing people to Azure pretty heavily. Has changed the competitive dynamics against Microsoft at all? And then two, as you look at next year and you look at sort of the growth rate of the services business and the backlog, just some color on pipeline and what that might look like, given sort of-- or what sort of comfort does that give you for next year? Those two things would be very helpful.

So with regards to Microsoft, yes, they are pushing quite hard to Azure. Actually, I think we-- I may say we even enjoy it. Because we don't-- we don't compete with them directly. So we do tend to get a lot of projects that are related. But I still think they are not such a significant player in this market, because if you compare them to Amazon and the rest of them, then Microsoft is a bit behind. Although we cannot ignore them. And they will be a significant player.

With relation to the backlog, or let's say the business that we see for next year, you know in our business usually when you start the year, 80% of the business is like-- I don't know-- I cannot say booked, but quite secured. So from the 80% we need to bring the additional 20%. And it's always when you start the year, it looks achievable. We found that way, and it's probably we do it with the (inaudible). And we need to take care. At the end it's a solid business.

Great, great. And then just a quick update on AT&T, have you seen any of the project work come back there at all?

Not really. You know, we saw some lately. In the last quarter we saw some new hiring from them. But it's still insignificant. I cannot say that it's a trend. On the other hand, we expanded a lot with CBS.

Got it. That's it for me, guys. Nice job, and thanks for taking my questions, and congrats.

Tavy Rosner, Barclays

Hey. Hi, Guy, Asaf, Amit. Just housekeeping to start with, you gave some good color on the top-line growth. If I remember correctly, it's 13% or 19% in constant currency. Can you give me some color of what was the organic part of it?

It was 50/50.

50/50. That's helpful.

(Inaudible) quarter you remember we bought some consulting company.

Right. So that's 9% organic, 10% acquired on the constant currency?

Yes.

Okay. That's helpful. And just wondering also on the margin side. So you mentioned 14.8% would have been the underlying number. What would be the right way to think about it as you enter 2016? I know you don't provide guidance, but do you think that you can squeeze some savings and push the number back above the 2015 level?

I can tell you one thing is that I'm not that happy with the 15%. I think we should be better. It's about the mixture of the revenues. And if we will see that this trend continues and the service part is more significant, then we will look for ways to improve the margin.

Yes, that's helpful. And maybe a last one, I was wondering on the demand side. When you look at the pipeline, do you come across a customer that would like to take the projects that are a bit hesitant due to CapEx constraints, and therefore you would see them coming more towards 2016?

I'm not sure I understand the question.

Like, do you see people hesitant to make the investment decision now, and they are kind of stepping on the side. They identify you as being the right provider, but now is not the right time to do the move?

You always see the ones that are quite decisive to move forward. And you have the ones that are hesitating. Every year we have the same thing. You have the ones that decide to push a bit and wait and get more comfort. And I think most of them usually you get the year after. Some of them decide not to do anything. It's always the case. Meaning I don't see anything different than previous--

That's helpful. Maybe very last one for me on the M&A pipeline, any color you guys can provide?

Hi. It's Amit. As Guy said, there was a small acquisition that we did last quarter. We have a few opportunities now that we are tracking. I hope that one of them will succeed. But definitely I can tell you that we are checking a company now.

Great. Thank you, guys.

Kevin Dede, Rodman

Hey. Amit, you said-- I'm pretty sure you said that last quarter you had two or three in the pipeline. I'm kind of wondering, from the M&A side, I'm kind of wondering what's changed there and why.

We are very conservative about checking those companies. And therefore those two opportunities we decided not to move ahead due to two reasons. One was the value of the company that they look for unreasonable multiples. And secondly the second reason was that it wasn't good enough for us.

Okay, can--

I think at the end, we can focus on them, and when you talk about M&A target, it's like-- either it happens or not. Meaning you can work the whole quarter, check the opportunity, get into (inaudible), and then at the end you may decide not to do the deal, or the other party may decide not to do the deal. So the fact that we are working on probably three or four every quarter, as Amit mentioned, we are quite conservative. We don't-- in a rush to spend our money for things that will not contribute, or in our eyes will not contribute enough. So this is the case.

And one more thing just to summarize this, companies that we currently disagree on the multiple sometimes, or let's say in some of the cases that we've experienced in the past even in most cases, those companies came back. And we even managed to close these. Either those companies improved their profitability and then they were able to meet the price that they were after, or that they came down and we managed to cut the price in the middle between us.

So the fact that we are, let's say, losing deals on the price doesn't necessarily mean that we won't get it back in the future.

Again to add to that in the companies that we like, and we want to move forward, if the gap is the price, in many cases as Asaf mentioned, you see a situation where we meet them like a year later or a bit more than that. And if they have met what they told us, and we keep all the records, then we get more comfort to go for them. And if they don't then the price is basically different.

Okay. So to summarize, it's pretty much based on valuation and performance as you're working with them through the process. Could you give me an indication on how you suspect valuations have changed over the past year? Do you think people are asking more, or how would you look at that?

People definitely ask for more. As you know, in many cases we find as competitors the private equity funds. Even private equity funds, they need to show a return on their cash flow. And they do not care about the amortizations and things that we suffer from. They pay a lot more. And we find quite hard to compete with them. And yes, definitely price has an impact.

So the two that we're able to work out, were they actually bought, do you think, in private equity, because they didn't meet your metrics?

If they are willing to get matched up--

No, they were bought because we didn't buy them.

No. I don't think so.

Okay, okay. Can you give us a little insight on that little company you did buy? I mean one of the things that you talked about from synergistic perspective was being able to deliver that company's capabilities internationally. And I'm just-- given that they were pretty much local in Israel, I'm just kind of curious on what kind of progress you've made there. Albeit it's a small contribution, I just wanted to get a feeling for how quickly you were able to bring their solutions to other geographies.

So just in general, because there are some legal, let's say, notification in the agreement that prohibits that from over-detailing certain aspects of the deal, at least in the near future; basically the company that we acquired is a company that is complementary to services that we already provide through our current activity.

So what they do is they enhance, let's say, mainly our service offering. The last candidate was a company that is mainly specializing in the telecom industry where we are active, and where we want to compensate what we currently are losing in business from AT&T. So in that aspect, it was to complement other services and enhance our offering.

In addition, also what we are looking-- in the companies that we identify, companies with let's say that provide higher level of services that can still bring us with more different gross margins then, let's say lower-value services. So we are talking about 25% to 30% or even over 30% in gross margin on those kinds of services.

Okay. I'm sorry. I didn't make myself clear. So I was curious about the company that you did close on. I think it was during the June quarter. And my understanding was that they had a specific service in managing mainframe computers. And that was a capability that you were hoping to bring to other geographies. And I'm just wondering if that type of solution has found customers in other geographies outside Israel.

Currently we didn't do anything outside of Israel. But we did sign a pretty big agreement with one of the giants in the market, which is something that without us, it probably wouldn't happen.

Okay. Well, good. Congratulations on that. And I missed some of the discussion around the gross margin. Would you mind just going over that again? I didn't understand why it fell sequentially.

Because again, most of the-- let's for example we'll take the impact from revenues that we had this quarter of $2.5 million. Then almost-- or let's say close to half of this amount refers to a devaluation of maintenance and software licenses that we sell. So for that amount that we lose, there isn't any cost of goods sold against that amount. So you get that directly into the erosion of your gross margin. So this takes us at least 1% of our gross margin. That's the main impact.

On professional services, even though the other half refers to professional services, because there the gross margin is much smaller, the impact is less magnitude.

Fair enough. Okay, so in a constant currency environment, given that we should see pretty much past the anniversary of the biggest changes, do you think gross margin stabilizes in the current quarter, or is it do you think more of a March quarter?

Again, it always depends on the mix. I think that on the average nine months, and again, based on-- in constant currency level today that should be the average gross margin that we've produced. Again, if there will be no M&A or something like that that would change the mix of the revenues of the Company.

Okay. One last question back to AT&T. I know you're kind of searching to supplement that loss. But do you have any insight on what they might be thinking, and whether or not you think things ever come back with-- I think that's Allstate.

No. The telecom industry went through quite a crisis. So it's very hard to say. Right now we are planning our budget at least nothing is going to change. And no, hopefully something will be better. But we cannot build on a positive change right now.

Are you trying to work with the consultants that you have there? And maybe addressing some of the other issues that some of these telecom companies are working through like for Wi-Fi solutions and--?

Some of them already work for other companies. And some of them we had to release. Because we don't keep any bench.

Okay. Well thank you very much, gentlemen, for taking my questions. I really appreciate it.

Jeremy Hellman, Singular Research

Thank you. And this is Debra filling in for Jeremy today. Thank you for taking my questions. I wanted to-- I appreciated your comments earlier about the business pipeline. And I wanted to follow up if you could tell us a little bit more about your salesforce and whether or not you're content with your headcount there, the number of people that you have in your sales team, and whether or not you might be planning on adding to it.

So first of all in terms of sales guys, we always plan on having sales guys. The main problem that it's very hard to find them. They are quite expensive, especially if we talk about US market. And it takes us like probably between 4 to 6 months until we know whether it's a good hiring or not. So the answer is yes. We always look to hire more sales guys. The situation is that we are not that successful with that. Whenever we hire someone, there is always someone that is going to another company, and therefore we're still around the same number.

Okay. All right, very good. So that's a competitive field. And then I noted that you had announced-- some months back you had announced a new reseller arrangement. And I wondered if you could comment then on the reseller approach to tapping into the market to reaching customers. Have you added resellers recently? And what are your plans for that particular channel?

I think for-- we are talking about-- whenever we add something, usually it's a partner. It's not a pure reseller. Usually it's a VAR. And we always look to add more partners.

On the integration side we do quite well, because of the demand to mobility and to big data and all the new world, the digital world. So we tend to recruit on that partners. But you know, we cannot announce all of them. Some of them are rather small. Some of them are not interested in the PR.

Okay. Okay, so you've probably added resellers and they just don't rise to the level or qualify for a press release, but you have been adding others to your roster?

Yes.

Okay. And then also I'm just curious about how do you have your salesforce and these VAR relationships? Are they focused on a particular industry? Are your salespeople vertically focused, or are they going out and reaching out to a variety of say, customer groups? I know you're concentrated in communications. Do you have salespeople that are focused exclusively on the communications market?

First of all in the telecom market, we definitely have the people that are specializing on this market. I think all in all, most of the sales guys are not kind of generic sales guys. Each one of them has his own knowhow and knowledge in what he sells. Otherwise it cannot work in our industry. We need the specialty.

Okay. So from your earlier comments about the competitive nature of finding qualified salespeople, do you think that you're underrepresented in certain industries and are not maybe getting penetration because you just haven't got the right salesperson there?

Definitely. I think the sales team is very important. And the fact that we are not that successful in keeping the number up influences the business.

Okay. Very good. Thank you. And then just one last-- maybe a little housekeeping question. Could you give us some guidance as to the split of the revenue along the three categories that you typically report in, software, maintenance and consulting services? How was that $45 million spread out amongst the three?

Basically if you look at our performance, even on our annual financial statement, you will see that we are approximately 30% in terms of-- in nominal terms, 30% of our businesses were maintenances and licenses, pretty much divided 50/50. And 70% portion of the business is professional services. But to that, I would like to add that because we provide end-to-end solutions when it comes to integration projects or to software development projects, sometimes we just don't differentiate between the software side and the professional service side of the project.

Normally we tend to provide the discounts over the price of the licenses and the software. Basically because of customer preference. As long as the total purchase-- the total price of the project fits our guidelines. So if I divide, let's say the more generic professional services that I directly link to a software that we sell, I would say that the actual percentage between software maintenance to professional services are 60 to 40 towards professional services.

Okay. So this quarter it sounds like was very similar to the previous mix is what you're saying?

Let's say that this quarter it was a little bit more to professional services. So if it's normal is 35--30 to 70, this quarter it was 25 to 75.

Oh, 25 to 75, excellent. Thank you so much for taking my questions. I appreciate it.

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

Yes. Thank you guys for joining us to this call. And hope to see you all on our next call. Thank you very much.

Thank you. This concludes the Magic Software Enterprises Limited third quarter 2015 results conference call. Thank you for your participation. You may go ahead and disconnect.