Magic Software Enterprises Ltd (MGIC) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Limited 2016 third-quarter financial results conference call. With us online today are Mr. Guy Bernstein, CEO; Mr. Asaf Berenstin; Mr. Itai Galmor, VP, Global Marketing and Business Development; and Mr. Amit Birk, VP, M&A and General Counsel. I will now turn the call 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 contents 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 third-quarter 2016 financial results. During this call I will provide certain highlights from our third-quarter results and then turn the call 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 to report our third-quarter results with record-breaking revenues of $54.5 million, reflecting 20% growth year over year, contributed both by organic activity and by the recent acquisition of Roshtov.

We released the latest version of our Magic xpa application platform earlier this month and are seeing a high level of adoption. This gives us a lot of confidence that we are on the right track to increase the retention and expand the wallet share among our existing customer base.

We expect this momentum and phase to continue throughout the remainder of the year. With our organic among both new and existing customers and the potential of ongoing M&A opportunities, I am very encouraged about our ability to maintain and improve our future performance and profitability.

Now I would like to turn the call over to Asaf, our CFO, to discuss the financial result in more detail. Asaf, please.

Thank you Guy. Good morning, everyone. As usual, before I jump into our results for the third 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 operation. There is a detailed reconciliation to non-GAAP results and financial tables in the earnings press release.

As Guy mentioned, our third-quarter revenue was $54.5 million compared to $45.3 million for the third quarter last year, reflecting 20% year-over-year growth. This quarter we started to consolidate Roshtov in our results. Nevertheless, the majority of our growth came from other areas of our business.

Looking at geographic breakdown, our revenue -- of our revenues, we maintained a diverse geographic mix with a slight change this quarter in favor of Europe, which includes the Israel revenue, mostly due to the acquisition of Roshtov.

For the third quarter, our revenues in North America represented 50% of total revenue, Europe represented 41% and APAC and the Rest of the World represented 9% of overall revenue. Slightly more than half of our growth in the third quarter came from the -- came from Europe, while most of the rest came from North America.

Turning now to profitability, our non-GAAP gross profit for the third quarter of 2016 was $20.1 million, up 20%, compared to $16.7 million in the third quarter of last year. Our non-GAAP gross margin, of 36.9%, remained virtually unchanged compared to the third quarter of last year and to the previous quarter.

Research and development expenses on a non-GAAP basis in the third quarter of 2016 totaled $2.7 million compared to $2.4 million in the same quarter of last year. This increase is mainly attributed to the acquisition of Roshtov.

Our non-GAAP operating income for the third quarter increased 17% to $7.7 million compared to $6.6 million in the same period last year. This reflects 14.2% of total revenues for the quarter compared to 14.6% of total revenues for the third quarter last year and 17.8% in the previous quarter.

Our non-GAAP tax expenses this quarter were $1.2 million, representing an effective tax rate of 22% compared to tax expenses of $0.9 million in the third quarter of 2015, reflecting an effective tax rate of 15%. We believe that our effective tax rate for the year will range between 20% to 21%.

Our non-GAAP net income for the third quarter decreased 7% to $5.3 million, or $0.12 per fully diluted share, compared to $5.7 million, or $0.13 per fully diluted share, in the same period last year. The decrease in our net income is due to an increase of $0.5 million in our financial expenses resulting from devaluation of net assets denominated in currencies other than the US dollar and from an increase of $0.7 million in net income attributed to non-controlling interests attributable to entities where we don't hold a 100% ownership.

Turning now to the balance sheet, we ended the quarter with approximately $61 million in cash and cash equivalents, short-term bank deposits and marketable securities, compared to approximately $77 million as of December 31, 2015. The decrease in total cash balance is due to the repayment of approximately $26 million mainly for the acquisition of Roshtov and $7.7 million paid to our shareholders in dividend since the beginning of the year.

From a cash flow perspective, we generated $5 million from operating activities in the third quarter and $18.4 million during the first nine months of this year.

Turning to our 2016 guidance, we are reaffirming our full-year revenue guidance in the range of $195 million to $200 million, reflecting an annual growth rate of 11% to 13%. In fact, we expect our full-year revenue to come in the high end of the range we provided.

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

Thank you, Asaf. So, in summary, a record-breaking top line and non-GAAP operating profit in Q3 demonstrates the successful execution of Magic's strategy to grow our business both organically and through acquisitions.

The growth of our existing activities shows that we are providing the software end services that enterprises need to succeed in today's digital world. And we are accelerating our efforts to enhance our portfolio with improved or additional products and services that appeal to our enterprise customers and bring profitability to our business.

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

Thank you. At this time we'll begin the question and answer session. (Operator Instructions). The first question is from Bhavan Suri of William Blair. Please go ahead.

Hi guys. Thanks for taking my question. Can you hear me okay?

Yes, we can hear you.

Great. Nice job there. Guy, just to first touch on your comment about seeing solid expansion within customers, can you just talk about what's driving that? And then is there specific products that are leading to it, or is it across both the integration platform, the mobile platform and the development platform?

I think it relates to all of them. The significant amount that we see is coming from the application platform because people need to migrate and prepare themselves for the new world. To some extent, you see the movement towards Cloud and some insignificant amounts coming around mobile.

Got it. Then just when you look at the business today and you look at it in the next three years and you see some -- and we've talked about this I think almost every quarter, you sort of see the services work and then you've also had some nice announcements of wins with licenses. Do you see that mix shifting, or do you think the mix to service or licenses still stays the same for at least the next two or three years?

I think we -- I can say that we can see it the same for the next two or three years, although there is a trend in the market. Customers are pushing more and more toward solutions rather than, to be frank here, between licenses and services. At the end of the day, our customers prefer not to deal with the event of separating it from the professional services.

Got it. It feels that the two stakes you guys took in the companies are doing well. Maybe for Asaf, what was organic growth in the quarter if I try and back that out from the Click contribution -- or Click's contribution? Would be great to get a sense of that too.

I confirmed that the majority of our growth came from our existing operation. And even if we have excluded the impact from Roshtov's results, we would have still shown a double-digit growth in the quarter and, of course, for the nine months.

Got it. Got it. Then one last one from me, actually, maybe two quick ones. One, you guys obviously announced the financing change and change of capital structure. Just an update, Guy, on the M&A pipeline. Are there larger companies you guys are willing to look to buy, given you still have a decent amount of cash that you decided to take on the debt? Just what does that pipeline look like and how amenable are you to much larger acquisitions than you've done in the past?

Okay. So we had a few opportunities. I knew that this one will attract some questions whether we have something to find more money or not. Well, the answer is, no, we don't have something (multiple speakers). But we thought that the interest rates were quite appealing for us and we said, okay, let's prepare for something which is big. In fact, the whole amount of cash that we have I think is approximately $90 million. Probably $20 million to $25 million we need to keep as ongoing cost for the business. So, at the end of the day, you have like $55 million, $60 million to work on the M&A side and take into account the cash flow that we generate and dividend that we pay. So, all in all, it's not a lot of cash to go for something big.

Okay, we can still get probably decent acquisitions. But if we want to go for something big, then we would probably need more. So we thought it's a good timing to prepare ourselves. The interest was appealing for us. The, chance, everything, so we did it. We could probably get a lot more than that, but we said let's start with that and see where it goes.

Got it, okay. And then one quick one. Just an update on the telecommunications vertical because you have some large customers in that space. There's been some challenges to that partially because of M&A in that space, a variety of other things. But how is that progressing and how does the pipeline look there? That's it from me, guys, thank you.

Let's put it this way, on the communication sector, I can say that on our main customer, which is Ericsson, we don't see that much of improvement. To some extent maybe a slight one, but from the others we see some positive change. Unfortunately, Ericsson is not doing that well these days, so as a partner, we don't enjoy the fact that they don't do well. But with the others, there is a positive change.

Got it. Thanks guys. Thanks for answering my question.

Thank you.

The next question is from Tavy Rosner of Barclays. Please go ahead.

Hi everyone. Thanks for taking my questions. Actually, most of them were just answered. Thank you for that.

The one I wanted to touch on is regards to the Cloud projects. This is something where many of your competitors are commenting that they see good traction with more projects coming to the Cloud. Is that something that you're seeing as well? And what would you say Cloud is in terms of a percentage of your total revenue?

Let's put it this way, we definitely see the trends. More and more projects are coming in. In terms of percentages out of revenues, I think it's still not big, like 10% maybe.

That's not so bad. And do you see the pipeline for next year (multiple speakers)?

Yes, it's growing all the time.

Yes, okay. In your best-case scenario where do you expect that coming up, let's say, by end of 2017?

Just the Cloud?

Yes.

It's very hard to say. But, I believe anyway it's going to improve.

Okay. That's very helpful. Thank you very much everyone.

Thank you Tavy.

The next question is from Kevin Dede of Rodman. Please go ahead.

Hello everybody. Asaf, you mention your geographic breakdown, but the numbers were too quick and a little blurry for me, so would you mind offering those again?

Yes, sure. Basically, you can also find those numbers also in the website. But the breakdown of our revenues were 50% coming from North America and 41% from Europe, which includes also Israel, and 9% from the Rest of the World.

Okay. Thank you. The gross margin has been pretty steady through the first nine months of the year, but not really at the level it was last year, and I was wondering if you guys could talk to that a little bit.

Yes, sure. Basically, it's related to the mix of revenues. The majority of the increase in our revenues comes from -- still are coming from (inaudible) from our professional services. So despite the fact that we saw an improvement both from our technology -- on the technology division and also on the professional service, in terms of gross margin we saw that diluted.

Okay. Fair enough. How would you recommend that we look at that going forward in light of your recent acquisition and changes in the business environment?

I think that on a constant level of our overall operation the 37% gross margin may, or should actually improve by 1% towards next year, again, as long as we don't do any acquisition in a different mixture.

Okay. I notice that you had a press release regarding a toy company and I was just wondering how you might characterize it. You've had a pretty good steady release of new business wins and I'm just hoping maybe you could add some dimensions to it and maybe we could get a feeling for the new business that you're winning versus the ongoing stuff you've had with existing companies -- or existing customers.

I think -- this is Guy. I think that our new business is maybe generated by what we call -- what the market calls digital transformation. It's basically the way the business moved from the old generation into the new era and it's a lot about convergence -- convergence of mediums, convergence of systems, integration between stuff.

Initially, the customers -- our customers want to see one thing. Their end customers want to see one thing. And when they want it I think our new -- you can see that in our press releases. You can see that in what we do, in the projects that we do and, as I have mentioned, it's going toward solutions. So we're taking our portfolio of products and our customers are embracing parts of it as a solution and it helps them.

Moose Toys was a great example of it. It's a great company and we're proud to serve them. I think we have more coming on.

Thanks for that color, Guy. So, taking it a step further, can you talk about how you're changing your workforce, where your employee level is now, given that this acquisition is done? And maybe offer a little color on where you think you're going to need the strongest skill set within your employee group in order to address the challenges that your customers are placing on you?

I think in terms of changing the people who represent us in the front, we need more skilled, high-level sales people to pitch to the customers. It's not any more about selling technology or selling a project. It's the understanding of the four walls of this digital world with all the new things, with all the new staff who is understanding the architecture of what the customer has today and where he wants to go, and the ability to lead him and instruct him how to do that. So this is the main change I've seen in the third quarter. It's more kind of a consultative sale.

You will see that mostly in the pre-sale area, where today, let's say, you see a change from the first time that we used to meet if he is keeping with that. We used to do our sale to the CTO or CIO of the company and the sale was more technological oriented. Now we do sale to the business people in the -- to the actual divisions, to the actual users, because again, as we said, we are moving to a solution sale rather than just selling technology.

Okay. That helps a lot. As you see your business shifting, are you facing other competitors, or do you think you're seeing more of the -- maybe the Andersen consulting companies that are coming down market to help smaller companies position their IT infrastructure, to adjust that company's particular capabilities in meeting its own customers' needs? I'm just wondering with the changes in your skillset, whether or not it's changing the competitive front and making it, perhaps, even more competitive.

I don't think so. If you ask whether we see the big guys, such as Accenture and Deloitte, in the competition, not really at the market that we compete. On the other hand, we definitely do see a lot of starting points for joint ventures with them where they bring the consultative part with the big projects and we do the delivery arm.

Okay. All right, last question for me. Just your perception of how the competitive -- or not the competitive market, the overall business market may be changing in Europe versus United States.

The typical change; Europeans are way more conservative compared to the States. In the States, you see the Cloud trend booming and moving quickly. In Europe, they are way more conservative. It's takes them more time. They need to prepare. You get the time yourselves to prepare. I think it's been like that for many years.

Okay, so no real changes there?

No.

Is the focus on the professional services, or the request for them, is that still stronger in the States than it is in Europe?

No, I think it's the same. I think in most organizations, whether it's the CIO or whether it's management, they prefer not to deal with a software vendor separated from the whole project or from the services. They want us to come as a one-stop shop, someone that will take the whole project and deliver it.

Okay. Thanks. Thanks very much gentlemen.

Thank you.

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

Thank you very much all for joining us this quarter and hope to see you next quarter and bring you some good news. Thank you.

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