Magic Software Enterprises Ltd (MGIC) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Limited 2016 second quarter financial results conference call. With us on line today we have Mr. Guy Bernstein, CEO; Mr. Asaf Berenstin, CFO; Mr. Itai Galmor, VP, Global Marketing and Business Development; and Mr. Amit Birk, VP, M&A and General Counsel. I will now turn the conference over to Mr. Amit Birk of Magic Software. Please go ahead.

Thank you and good morning, everyone. Our quarterly earnings release was issued before the market opened this morning and has been posted 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 content of this call. Magic expressly disclaims any obligation to update or revise any of these forward-looking statements whether because of future events, new information, a change in its view or expectations, or otherwise. Also during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press release issued before the market opened this morning. 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.

Thank you, Amit. Good morning, everyone, and thank you for joining the call today as we report our second quarter 2016 financial results. During this call, I will provide selected highlights from the second quarter results 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 yet another strong quarter highlighted by double-digit revenue growth. Revenue for the second quarter reached $47.4 million reflecting 11% growth year-over-year. This growth comes despite the fact that we continue to experience a decline in the Telco sector. Our diversified portfolio enables us to compensate this decline by winning new business. So, I'm confident that we will continue this positive sales momentum and continue to deliver double-digit growth and improved profitability throughout 2016.

Following the delivery of our latest version of our Application Platform Magic xpa 3.1 during Q1, this quarter we launched the latest version or our Magic xpi Integration Platform. Magic xpi 4.5 includes an updated studio, a new connector to facilitate IoT projects, and a Connector Builder (SDK) which enables partners and end users to build their own full featured connectors. While just in the market, we are already hearing great feedback and gaining new partners. We are also seeing a growing number of customers using our software and professional services for cloud and mobility projects. All this shows that our portfolio provides solutions that meet market needs and satisfy our customers. At the same time we're excited to have executed on our M&A strategy with our recent acquisition of the Clicks Development Platform, which we announced in the second quarter and closed only recently. Clicks further broadens our portfolio and enabling us to target the healthcare markets and bring higher margin associated with photo sales.

Now I'd like to turn the call over to Asaf, our CFO, to discuss the financial results in more detail. Asaf, please.

Thank you, Guy, and good morning, everyone. As usual before I jump into our results for the second quarter, I would like to remind you that we are presenting our results on a non-GAAP basis, which as mentioned at the beginning of the call gives a clear view into the operational state of the business and provides valuable supplemental information regarding our results of operations. There is a detailed reconciliation to non-GAAP results in the financial tables of the earnings press release. As Guy mentioned, our second quarter revenue was $47.4 million compared to $42.5 million for the second quarter last year reflecting 11% year-on-year growth. Looking at the geographic breakdown of our revenues, our geographic mix remained steady during the second quarter.

North America represents 50% of our total revenues, Europe which includes Israel revenues represents 39%, and APAC and the rest of the world represents 11% of total revenue. Half of our growth in the second quarter came from North America while the rest of the growth was evenly distributed across all other regions. Turning now to profitability. Our non-GAAP gross profit for the second quarter of 2016 was $17.5 million, up 7% compared to $16.3 million in the second quarter of last year. Our non-GAAP gross margin declined to 36.9%, down from 38.3% in the second quarter of last year. The decrease in our non-GAAP gross margin resulted mainly from the shift in our revenue mix from software towards professional services. This includes hiring more than 100 new employees in professional services segments during the first six months of this year.

Having just been onboarded, these new hires have yet to reach their maximum productivity. Our non-GAAP operating income for the second quarter remained constant at $6.5 million compared to the same period last year reflecting the 13.8% of total revenues for the quarter compared to 15.2% of total revenues for the second quarter last year. Our non-GAAP tax expense this quarter was $1 million representing an effective tax rate of 15% compared to tax expense of $900,000 in that second quarter of 2015 reflecting an effective tax rate of 14%. We believe that our effective tax rate will continue to increase towards 20% to 21%. Our non-GAAP net income for the second quarter remained constant at $5.2 million or $0.12 per diluted share compared to the same period last year.

Turning to the balance sheet. We ended the quarter with approximately $82 million in cash and cash equivalents, short-term bank deposits, and marketable securities compared to approximately $77 million as of December 31, 2015. From a cash flow perspective, we generated $2.3 million from operating activities in the second quarter and $13.4 million during the first half of this year. Turning to our 2016 guidance. We are raising our guidance for 2016 full-year revenue to $195 million to $200 million from $191 million to $195 million reflecting a revised annual growth rate of 11% to 13%. Our revised guidance is the result of our visibility into our second half of the year along with our recent Clicks Development Platform acquisition.

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

Thank you, Asaf. So in summary, we are pleased to report another quarter with year-over-year double-digit revenue growth. Our financial remained strong during the first half. Cash flow from operations reached $13.4 million contributing to our total cash position of $82 million. We are happy that our diversified portfolio provides the software and the services enterprises need to succeed in today's digital age. With that, I will now turn the call over to the operator for questions.

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator Instructions) Bhavan Suri, William Blair.

Just to start off first with the acquisition of Roshtov, they're obviously in the healthcare space. I guess just a lot more color about the size of the company, its growth rate would be helpful, and then also just as you think about it, this is a first sort of very specific vertical acquisition you made. Is this a strategy you guys plan on doing going forward sort of being more vertical specific?

In terms of the size of the acquisition, it's rather not a big company. It's a small company specified in the healthcare market while the Clicks itself is a generic platform meaning we need to check and to see how we take it further from here while at the same time going deeper into the healthcare industry.

So I guess different way to think about it, Guy and maybe this is for Asaf too. When you saw the beat in the quarter and the raise, was that largely inorganic or a mix of organic or inorganic sort of revenue? So, was it your core business or was it Roshtov that actually drove some of the upside?

First of all, Roshtov although we announced the transaction during the second quarter, the closing was done just recently so we didn't have any impact of Roshtov numbers in our number. This is one thing. On the other hand, if you compare the second quarter activity to the first quarter, then all of the growth practically is organic.

Before we turn it over, more fundamentals just on numbers quickly. Operating margin came down a little bit. Could you just go through the puts and takes there? What was the reasoning there?

As we explained, during probably the last two to three years we are suffering from the telecommunications sector heavily and at some point we need to compensate for that. So when you hire new employees and you put them up to speed, it takes a bit time till they get into full production. This is one thing. And the other thing, we had to leave out a bit on the margins in order to gain new projects because at the end of the day you as someone who's part of the Company, you want us to be able to mitigate the risks and not to disappoint. So it affected a bit the margins, I think within the second half we will see it coming back.

Okay. And then just turning to the fundamentals really quickly. In a competitive environment with the launch of the connectors, the connector building for xpi specifically, we've always talked about sort of some of the older legacy players. Are you seeing any of these new players like MuleSoft or Talend or anyone else in that space at all sort of doing the application integration or data integration?

It's varied between the projects. When you go for the enterprising projects, then the answer is no. When you go after the new trend, then yes, definitely you will see the newcomers. It's rather a small [play] on the new trend.

And then just last one from me. You guys have decent exposure globally and then the Telco weakness I suspect is your old long-time customer. But just any color if you're seeing anything from Brexit, anything from European customers in the space at all that might suggest a slowdown there or some uncertainty?

No. Let's say most of our customers are mid-sized companies, software houses, so this is not something that we saw any impact. And also in terms of currency rate with the revaluation of the British pound, this is something that for that matter was compensated by the strengthening of the Japanese yen. So, it didn't have any impact on our revenue or should we expect it to have an impact, no significance.

Nice job on the beat in the quarter. Thank you.

Tavy Rosner, Barclays.

Let me just follow up on the question regarding the acquisition. Can you just expand a little bit about the investment rationale? What do you expect from this acquisition? Is it more to penetrate the medical market let's say abroad to export this solution to different players outside of Israel or is it just on the technological side that you can just take Clicks and apply it to different verticals?

I would say that we look at it from three different angles. In terms of the acquisition itself, I would say that we secure the downside meaning the company probably will deliver a decent return on investment. So, in general talking about the downside of the acquisition. The second angle, we're going after the healthcare industry. They have lots to offer in this sector and part of it will take time to go deeper into the sector, but we definitely believe that we have a lot to offer there. And the third thing is to see how we can use the economics of scales and do things together and boost the technology.

Do you have a sense of what's the size of the opportunity on the healthcare side?

It's huge, but it needs a lot of work because currently you need to break the whole thing into components in order to be able and penetrate because in each country, this healthcare industry is highly regulated in most of the countries. So in order to penetrate, you need to break this whole thing into components and go with a smaller proposition in order to do some business. It needs some work.

And you mentioned that you were hiring new people when you talked about the impact on operating margins. Can you give a sense of where you're hiring and for what function and are you happy with your current workforce size?

We had to compensate for the declining business in the Telco industry, therefore we had to go after other projects. In some cases, compromise on the margins in order to recover some of the revenue. So, this is most significant part and as you know when you hire people, it takes you time to bring them up to speed and in full production. So, this is what we saw. But we already feel much better in terms of where we are.

Kevin Dede, Rodman.

Just again to go back to Clicks. Can you give us sort of a profile of their current customer base, maybe give us feeling for the revenue run rate, and then what and how you paid for it?

Most of let's say their customers are big healthcare organizations in Israel and when I say big, I don't know if you know the Israeli market. I think if you take for example one of their customers is probably the second largest healthcare organization in the world because in Israel it works a bit differently. This is one thing when you work with such big organizations. In order to penetrate other countries, you need to break it down into components so you can penetrate easier and this is what we want to do.

So, I mean there are all sorts of different types of healthcare organizations. Are we talking a drug company, are we talking about hospitals, insurance?

We are talking about big healthcare organizations and hospitals.

How about a view into the revenues that the company is generating and what you paid?

What we paid we already announced. In terms of revenues, this company is not a big company, it's rather a small company in terms of revenue. We believe it will be highly profitable.

How about the headcount?

[100].

So, that's on top of the 100 that you mentioned in your prepared remarks that you hired through the first six months of the year?

As Asaf mentioned, nothing is included in Q2 results.

Can you give me the headcount at the end of the quarter for the total Company and what it was at the beginning of the year?

1,300 we had at the end of the second quarter versus close to 1,200 at the end of the year.

OpEx was a little bit higher, is that anything that we should expect to continue going forward? Was there something unusual in that?

Can you repeat the question?

I guess I'm wondering what you'd expect going forward, do you think it sort of settles in at this $11 million level?

What?

Your operating expenses.

I think that basically let's say if we speak about operating margins, that would be easier for me. I think that for the second half and towards next year, we are expected to come close to again to the 15% and over.

Okay. Gross margin, I guess given sort of the change toward professional services, is that something that you think will be sort of consistent with where you fell out in the June quarter and even the March quarter a little bit?

I think we should improve that in the second half because the second half usually is more towards 4Q sales. So, I think in the second half we should be a little better on our gross margins.

Given your one deal here, I think last time we talked about it, you mentioned that there were a few that you were working on and I was wondering if you could sort of review your acquisition pipeline and how you see the market. I know that the commentary has typically been that you've seen a lot of equity chasing businesses too. I'm just kind of wondering if you think any of that has changed and how your pipeline looks now?

In terms of pipeline, we still have like three companies in the pipe that we are in negotiations. In terms of the cycles, I must say that because there is a lot of demand for companies and the P/Es are paying much higher amount and much faster, it's not getting any easier. But on the other hand, the ones that we are in negotiation it looks like we will be able to close at least one of them. But it's not getting any easier in terms of prices, in term of multiples, in terms of what people are expecting.

Do you see maybe more software incubation in Europe or do you think that's changed at all? I guess what I'm trying to ask is sort of the origin of some of these smaller companies. Do you see them developing in Europe or is it still I don't in the most part Israel and US?

Most part Israel and US.

Okay. The overall market I guess you commented on it a little bit, there doesn't seem to be much of an effect from Brexit. Are you still trying to push mobile applications to your customer base and across your customer base? How do you see that progressing? Is that still something that your customers are interested in doing or is there more resilience to it?

I think for most of our customers, you see a lot of interest around mobile capabilities. In some territories we see that it's growing faster in terms of the project, in terms of the size of the project. We definitely see a trend in Japan. I think Europe depends where in Europe, probably in the UK you see more companies are pointing towards mobile and it varies between the territories.

Your view on the second half has obviously improved. Can you speak to some of the drivers there specifically what types of applications, number one and then number two, which geographies?

I'm not sure I understand your question.

Okay. Your view on the second half of this year is obviously improved with your raise in guidance and I'm curious to know in which applications you think your customers are more interested in deploying now than you saw them earlier this year. So, what's changed from an applications perspective and which geographies do you think are stronger now?

So in terms of the applications, we want kind of an ongoing business. We work a lot with our partners and therefore they get their own pipeline and we share their pipeline. So, we see the pipeline and we know what to expect from them, that is one thing. In terms of the applications, you see things all over from mobile projects, cloud projects, all kind of preparation projects for both mobile and cloud, all kind of projects migrating from previous versions to newer versions, we see all of that. In terms of territory so definitely we see an improving trend in Japan, I think in the US we see a good trend, in Israel we see good businesses. In Europe, it varies between, we have a strong business in Germany. So, it depends on what territory we're talking and what kind of projects. On the other hand, the (inaudible) from the telecommunication sector we had to recover from other places.

Do you think that this increase in business is something that will continue into next year or do you think this is just a surge in spending because companies have a budget they have to flush out?

Very hard to answer this one. If I had the answer, I could make a lot of money. Based on what we see in the pipe, it looks like a trend. But all this crisis like what happened in the UK, an unexpected one the incident, they have some impact on the business. So for now I can say yes, it looks like a trend.

Is Amit still there? Amit, can you give me a call later today when you have a minute?

No problem.

Congrats on the nice job and thanks for taking all my questions. Appreciate it greatly.

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

Thank you, everyone, for joining our call. And we sure hope to see you in our next conference call. Thank you very much.

Thank you. This concludes the Magic Software Enterprises Limited second quarter 2016 results conference call. Thank you for your participation, you may go ahead and disconnect.