Magic Software Enterprises Ltd (MGIC) 2017 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Limited 2017 First Quarter Financial Results Conference Call.

With us on line today, Magic's CEO, Mr. Guy Bernstein; and Magic's CFO, Mr. Asaf Berenstin.

Magic's 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 Company's press release issued today also applies to the content of this call. Magic expressly disclaims any obligations 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, Magic will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in the press release. A replay of this call will be available after the call on the Investor Relations section of the Company's website.

I would now like to turn the call over to Mr. Guy Bernstein, CEO of Magic Software. Please go ahead.

Thank you. Good morning, everyone and thank you for joining us today as we report our first quarter 2017 financial results. I will provide you with the highlights of our first quarter results and then turn it over to Asaf who will provide more detailed financial information. I will be happy to address any questions at the end.

We are pleased to report a strong start to the year with the Q1 revenues reaching a record-breaking $60.7 million, reflecting 36% year-over-year growth and non-GAAP operating income increasing 20% to a record-breaking $8.4 million for the quarter. With the strong trends in the integration market, we continue to be recognized by top industry analysts for our leading platform offerings. As we increase our focus on the growing integration market, we announced the opening of our R&D center in St. Petersburg in order to improve competitiveness and to shorten time to market. We also released Magic xpi 4.6 which let's use (inaudible) get even more value from our code-free integration platform.

These positive results confirm that Magic's diverse portfolio is providing the software and services demanded by today's enterprise customers. We remain very positive about our ability to accelerate growth and ramp up operating profits in 2017.

Now I would like to turn the call over to Asaf, our Chief Financial Officer, in order to discuss the financial results in more detail. Asaf, please?

Thank you, Guy, and good morning, everyone. Before I jump into our first quarter results, 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 first quarter revenue was $60.7 million compared to $44.7 million for the first quarter last year, reflecting 36% year-over-year growth with 10% growth compared to the fourth quarter of 2016. Analyzing our revenue growth, our organic growth rate was 18%, accounting for half of our year-over-year growth. Compared to the fourth quarter of 2016, all of our growth was organic. Together with the start of the anticipated renewal of software licenses among some of our larger enterprise customers, we were able to deliver positive results across all financial metrics.

Looking at geographical breakdown of our revenues. Our geographic mix remains steady during the first quarter. North America accounted for 47% of total revenues. Europe, which includes Israel, 46%, and APAC and the rest of the world accounted for 7% of our quarterly revenue. Most of our growth in the first quarter was from North America and Israel, which are strong (inaudible) Magic.

Turning now to profitability, our non-GAAP gross profit for the third quarter of 2017 was $21.4 million, up 28% compared to $16.7 million in the first quarter of last year. Our non-GAAP gross margin was 35.2% down from 37.3% for the first quarter of last year, and remaining steady compared to the previous quarter. The decrease in our gross margin compared to the respective quarter resulted mainly from the shift in our revenue mix from software towards professional services. The breakdown of our revenue mix for the first quarter was 31% software solutions and 69% professional services versus 35% software solutions and 65% professional services in 2016 as a whole.

R&D expenses on a non-GAAP basis in the first quarter totaled $2.9 million compared to $2.3 million in the same quarter of last year. The increase in our R&D expenses is a result of our growing focus on expanding our integration offering and from the recent addition of Roshtov to our business portfolio. Our non-GAAP operating income for the first quarter increased 26% to $8.4 million compared to $6.7 million in the same period last year. This reflects an operating margin of 13.8% for the quarter compared to 14.9% for the first quarter last year and 13.2% in the trailing quarter.

The reduction in operating margin compared to the respective quarter is primarily attributable to the decrease in gross margin as I explained earlier, as well as to higher R&D and SG&A expenses.

Our non-GAAP tax expense this quarter was $1.4 million, representing an effective tax rate of 18% compared to tax expense of $1.4 million in the same -- in the first quarter of 2016, reflecting an effective tax rate of 21%. We believe that our effective tax rate for the full year of 2017 will range between 20% and to 22%.

Our non-GAAP net income for the first quarter increased 19% to $5.7 million or $0.13 per fully diluted share compared to $4.8 million or $0.11 per fully diluted share in the same period last year. The increase in our net income is consistent with the above-mentioned increase in our revenues and operating profit.

Turning now to the balance sheet. As of March 31, cash-and-cash equivalents, short-term bank deposits and marketable securities amounted to approximately $99.8 million compared to approximately $87.8 million at the end of 2016. During the quarter, we raised $5.5 million in new bank debt to partially finance payments towards acquisitions. The loans are based on New Israeli Sheqels and are to paid back on a monthly basis over the period of two years to three years.

Operating cash flow this quarter totaled $10.5 million compared to $12.2 million in the respective quarter. I would like to remind you the June -- the third quarter, we declared a cash dividend in the aggregate amount of approximately $3.8 million or $8.5 per share with respect to our 2016 second half results of operations, which was stable and consistent. This is in accordance with our dividend policy for our shareholders in which we return up to 50% of our net income in form of a dividend. Our gross dividend yield is approximately 2%.

Lastly, I would like to reiterate our 2017 full-year revenue guidance, which we expect to be in the range of $225 million to $230 million, reflecting an annual growth rate of 12% to 14%.

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

Thank you, Asaf. In summary, we are pleased to report a strong start to the 2017 fiscal year with record breaking revenues and double-digit growth on both our top and bottom line. We showed positive results across all financial metrics due to continued solid demand for our product and Professional Services.

We are confident in our growth strategy and remain focused on enhancing our portfolio both organically and through acquisitions to best serve our customers' needs for forward-looking software solutions.

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

(Operator Instructions) Tavy Rosner, Barclays.

Hi, everyone. Thanks for the presentation. First question, last quarter you talked about some deals -- renewals of deals with large enterprise that were taking some time to materialize. Is that something that you are seeing now as we finished the first quarter or looking into the second half of the year, you have better visibility on the timing of those?

Yes, what we explained last quarter is that the renewals in some of the large customers that we have is -- basically renewed in between three years to five years. And every like -- every time, the fourth year is a suffering a bit from a lack of renewals because based on the timelines of the renewals, the fourth year is usually weak, and yes, definitely we started to see it again, we already closed two of them and it's moving forward. So well, yes definitely the answer is yes.

Okay. That's very clear. And looking at the margins, I guess this is the result of the mix, probably more service-oriented than software, is that the mix that you expect to continue for the remaining of the coming quarters?

Yes, we push on the time to improve a bit towards software rather than services. But if we make good margin on services, then we don't say no. So I cannot say unfortunately, but we pushed for both with more focus on the software side.

Right. And then lastly, if I may, can you remind me the rational for the R&D facility in Russia that you opened, like what's the rationale for opening it there and what capability that it add for the Group?

We are trying to leverage, we have -- we already have a facility in Russia and that is dealing basically with the same stuff that we have here. And we are trying to leverage on their capabilities, because they know the technical part, they are very good and no need to mention that on the cost side, it's cheaper for us and we want to leverage on this one because we feel that (inaudible) into this market.

Bhavan Suri, William Blair.

Hi guys, this is Sarah Shizas in for Bhavan, thanks for taking my question. Just generally, how was the overall demand environment for your integration platform? And then if you could provide any color on your mobile and cloud application business, how that trended during the quarter, and kind of where you -- how big of a portion of total revenue is that currently?

Okay. So on the integration side, we definitely see an improvement. No need to mention that the whole trend in the market with lately the IPO for [NuSoft] is pushing a lot the industry. And definitely we intend to push more on this one because at least from the technology side, we feel that we have a lot to offer and nothing that is less than [NuSoft], this is on the integration side.

Then the mobile side, we still see the demand, it's as I mentioned, all the time most of the project that we see around mobile, the vast majority of the money is not around mobile itself but in order to be there, you must fill the checklist. So a lot of the -- I would say, the kicker for the projects are coming from the mobile side, but we are talking about big projects.

Okay, thank you. And then just quickly the update on the M&A pipeline, what are you seeing out there?

Well, currently we have like three companies that we are checking, I cannot say that any of them is like in a maturity stage that I can discuss about it. But all in all, we feel quite confident because even without the M&A, we feel quite strong on starting the year. That's it, nothing discuss yet about the M&A that we have on the table.

Okay, thank you. And then one last one if I may, just in terms of the verticals, are you seeing any strength on any particular verticals?

I believe on the integration side, we see some movements, all in all we feel that the business is doing better. We feel that it's a -- with more deals that we were working on, we are becoming more mature and the cycle of closing deals is shortening. We feel quite good about going forward.

Kevin Dede, Rodman & Renshaw.

Hi gentlemen, thanks for taking my questions too. Couple of things, listen, you did so well in the March quarter that your expectations for the balance of the year seem to be ultra conservative, and I'm just wondering what you're seeing versus what you really feel comfortable communicating? It just seems to me based on sort of low double-digit growth as you posted to the four quarters last year that you could easily surpass the top of your guided range. And I was just wondering if you wouldn't mind talking to that a little bit please, Guy?

Okay. So first, yes, you are right. We are being a bit over conservative. We felt that instead of running and upgrading the expectation, we want to go deeper into Q2 and then kind of feel more comfortable to come up with new expectations. At the end yes, we are conservative. I don't want to be -- Kevin, I don't want to be in a position that I am running to upgrade the expectation and then I'm struggling to deliver because it's just Q1. (multiple speakers).

No, no, I understand. But to your point Guy, we're halfway through Q2, we are almost -- you should be able to see pretty much the halfway mark for the year.

Kevin, on that aspect I don't think that -- first of all, I don't think that we are ultra conservative. I think as Guy said, we are conservative. As you see that, we have lots of projects that are being done in our Professional Services side. We have significant amount of business, 35% of our business today is being carried out from Israel. This quarter in Israel, there was no vacation, no holiday season. In Q2, for example, we have the April holidays, Jewish holiday, Passover, that would impact our revenue to some extent. So in terms of our forecast for the end of the year, even if we will top that and I am sure that we will, it will be in a couple of percentages, so and that said (inaudible) we are ultra conservative.

Okay, thanks Asaf. Guy, I think this whole trend toward integration is really interesting. And I think it -- especially given the strength in your service business, I know it was tough there with all states for a while, but it seems to me that you've got that realigned and now you've got this other driver in the integration. And I was wondering if you wouldn't mind talking a little bit of more about xpi 4.6, the fact that it's code-free and how you see it because you mentioned that you see it technically superior to recent competition. And I'm wondering if you wouldn't mind adding a little more detail about that and specifically with regard to the length of those projects.

So I'll try to put it simple. The idea behind the xpi (inaudible) that you can just put it as a heart in the organization and you can drag and drop between all kind of platforms or servers or whatever you have there in a very graphic way, you don't need to be an IT expert in order to integrate between all kinds of systems. And I think one of the things that we bring to the table, on top you mentioned this, the professional services side is that everyone is talking about integration solutions on the cloud and so on, but at the end, the big projects coming from legacy environment with big organizations. And this is where we are headed to.

On top of course, we are providing cloud solutions as well, but the dominant triggers for such projects are coming from legacy environment. And I think this is an environment that we understand very well. Is that clear?

Yes. So could you just -- I mean, I'm sure you've seen the software -- this IPO and I'm just wondering where -- I mean you spoke to your advantages and I just wanted to make sure that I understood them specifically.

It's about the advantage of going across the board, it's like there is nothing that others such as [NuSoft] have that we don't, this is one thing. The other thing is, they think we -- in many cases, we come up with ready-made solutions for specific environment and ecosystems. So if I'll give you an example, if a common integration is between whatever SAP and Salesforce or SAP and SugarCRM or JDE. So we have all of the those like out of the box playing, you can just plug and play, so it's nothing that you need to do and play with a technology in order to make it work, it's like it's there. And we have a lot of experience with it.

So I think in terms of the understanding of the market and where we are in this market, I think we're -- it's for a reason that we are highly appreciated by the top industry analysts.

Would you say that you have that same flexibility across an Oracle platform that you do in SAP?

Of course.

Okay, fair enough. Thank you.

This is where we started with, the flexibility, being agnostic to all the platforms out there.

(inaudible) xpi tool contains more than 100 different type of connectors to different systems that [are out there]. So of course they relate also to that.

Okay. Asaf, just on SG&A, sort of non-GAAP kind of a big pick up and I'm just wondering how that -- what the variable component of that expense is and how it ties to revenue?

First of all, we have additionally workforce that are being added, mostly now in our Salesforce. In that aspect, we are investing in our marketing, we are participating in exhibitions and all that aligns with putting our products and our integration platform ahead, all of that bring up our level of expenses. G&A to that extent, if you would measure our G&A, our SG&A as a percentage against our revenues, you would see that they even dropped by approximately 1%. So they are growing in line with our revenues, but are still in a lesser extent.

Do you see that balance sort of fairly consistent for the year or just what's your view on your future expense there?

I think that as a percentage again, our revenues, we will retain the same level.

Okay. And Asaf, you went so quick on the mix between software and service in March 2017 versus March 2016. I apologize for asking for this, but would you mind just repeating those figures for me, please?

It is 31% towards software solution versus 69% towards professional services.

Okay. Was that the same, I guess, what I mean --?

No, in 2016 as a whole, we were at 35% on software solution versus 65% on professional services.

(Operator Instructions) Kevin Dede, Rodman & Renshaw.

I figured that since nobody else was going to ask, could you just sort of talk a little bit about the debt level versus cash? I know you spoke to paying your dividend, but it just seems that given that there is nothing pressing in the M&A pipeline, I'm just kind of wondering what you're thinking?

First of all, we think that interest rate are very cheap today. So as you can see, whenever we take loans (inaudible) maturity of between three to seven years, we took around [$32 million] worth of loan. In Magic we have some entities in which we are -- in which we partner with the founders and whenever we do acquisitions, we'll grow the business from their organization, then we prefer to take leverage that is being, let's say, balance between us and the founder.

That on one hand. On the other hand, again, if you look at 2016, you would see that we did approximately four to five acquisitions. So for us it's better to be prepared with the cash at hand rather than once you have a deal and go and start running after the cash.

I will try and make it more clear. Whatever we generated cash is more than enough to pay the dividend and to deal with the, I would say small acquisition that we do here and there in the subsidiaries. We still keep the level of quite high cash because we still look for the next big thing that we can leverage on and acquire. And I think this is the reason behind it.

Okay, Guy, that's consistent with commentary in the past. I appreciate that.

I guess the big question is given that there are always things that you're looking at, I'm just -- and I know you said there is nothing pressing, I'm just wondering, typically valuations or at least through most of last year, you got really got a lot of stuff done last year. But there were other things that you're looking at that you didn't get done. I'm just wondering if you could speak to valuations in light of IPO activity?

You are talking about valuations about the company that we check -- the company that we are checking?

Yes, sir.

So it varies between companies that are dealing with technology or companies that are dealing with professional services. Of course, there is nothing to compare, professional services, again if we -- usually we are trying to go for unique skills that will complete our offerings. And yet again, on the professional services, I think we do quite good acquisitions, we buy them rather cheap.

On the technology side, it's more tricky because if you go for mature businesses with high volumes, usually they have banks to represent them and prices are quite high. This is the main reason why till today we didn't do something significant on the technology side. On the smaller companies, we tend to bring them to reasonable prices and then, it differs between young companies that -- they think they have a bright future and usually they want to see a higher valuation. And I would say probably old companies or mature companies that understand that they have this feel that they reach to a certain level and from here on, they will need to partner with someone bigger that can take them to the international world. By the way, we are in some discussions with a very interesting company right now, that are in the exact position, meaning, it's a nice company, profitable, but it's very local in Europe and it's clear to them and for us that together we can bring it to the next level.

Still, there is a gap in terms of what we are willing to pay and what they want to fix. So on the technology side, I would say it's not easy.

Right, you are right. And if I remember correctly, you made an acquisition similar to the one that you just spoke to early last year, a small Israeli company, mainframe coding, didn't have access to the grand global market and you were able to do that. Is that true?

Yes. And now it's a different company in Europe.

Right, okay. So just to reaffirm what Asaf mentioned, you were able to finish four or five last year? Closed four, five acquisitions?

Yes.

Okay. And then Asaf spoke to organic growth.

18%.

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

Yes. Well, thank you very much all for joining us for this time and I hope we'll bring you some more good news in the future. Thank you.

Thank you. This concludes the Magic Software Enterprises Limited first quarter 2017 results conference call. Thank you for your participation and you may go ahead and disconnect.