Magic Software Enterprises Ltd (MGIC) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Magic Software Enterprises Ltd.

2018 Second Quarter Financial Results Conference Call.

With us on the line today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's Software Division VP of Technology and Innovation, Mr. Yuval Lavi; and Magic's VP, M&A and General Counsel, Mr. Amit Birk.

I will now turn the conference over to Mr. Amit Birk of Magic Software.

Please go ahead.

Thank you, and good day, everyone.

Our quarterly earnings release was issued before the market opened this morning, and it 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 non-GAAP financial measures.

A reconciliation schedule showing the GAAP versus non-GAAP results has been provided in the press release issued before the market opened this morning.

A replay of this call will be available after the call on our Investor Relations section of the company website.

I will now turn the conference over to Mr. Guy Bernstein, CEO of Magic Software.

Please go ahead.

Good morning, everyone, and thank you for joining us today as we report our second quarter 2018 financial results.

We are pleased to report another strong quarter as we continue our forward momentum with consistent year-over-year organic growth in our revenues, operating income and net income, which clearly demonstrates the solid execution of our well-defined corporate strategy.

Our Q2 revenues for 2018 reached a record $70.2 million, reflecting 7% year-over-year organic growth.

Operating income for the quarter increased 26% year-over-year to record $8 million and non-GAAP operating income increased 9% year-over-year to record-breaking $9.8 million for the quarter.

We continue to strengthen our competitive advantages with products and solutions development as we expand our footprint in all areas that we have identified as the fastest growing, including integration and low-code application development markets.

Our positive results are driven by the increasing demand for our diverse portfolio of innovative software solutions and professional services, evidenced by our ever-expanding base of new customers and strategic partnerships with major organizations and ecosystems, including a recent partnership with Microsoft.

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

Asaf?

Thank you, Guy, and good morning, everyone.

Our second quarter revenues totaled $70.2 million compared to $65.5 million for the second quarter last year, reflecting 7% year-over-year growth driven exclusively by organic expansion, with software license and maintenance and support revenues contributing 50% of the growth and professional services contributing the remaining 50%.

Looking at the geographical breakdown of our revenues during the second quarter.

North America accounted for 46% of total revenues; Israel, 37%; Europe, 12%; and APAC and the rest of the world accounted for 5% of our revenue.

Most of our growth in 2018, in absolute numbers, resulted traditionally from North America and Israel, which continue to be our strongest territories.

North America accounted for 39% of our growth and Israel for 47%.

Turning now to profitability.

Our non-GAAP gross profit for the second quarter of 2018 was $23.4 million, up approximately 5% compared to $22.3 million in the second quarter of last year.

Our non-GAAP gross margin decreased to 33.1% compared to 34% in the second quarter of last year.

The decrease in gross margin was mainly attributable to a 25% increase year-over-year in the rebate rate for our largest customer amounting to $300,000 resulting from increased level of operations, with the remaining decrease resulting from certain low-margin projects.

The breakdown of our revenue mix for the second quarter of 2018 was approximately 30% related to our software solution and 70% related to professional services, the same as 2017 as a whole.

Moving to operational costs.

Research and development expenses on a non-GAAP basis in the second quarter of 2018 totaled $2.7 million compared to $2.8 million in the same quarter of last year.

Our non-GAAP operating income for the second quarter increased 9% to $9.8 million compared to $9 million in the same period last year.

This reflects an operating margin of 14% for this quarter compared to 13.7% in the second quarter of 2017 and 13.9% in the first quarter of 2018.

Our non-GAAP tax expenses this quarter totaled $1.6 million compared to a tax expense of $1.7 million in the second quarter of 2017.

Our effective tax rate for the first half of 2018 and 2017 was approximately 19% compared to 21% [point three] in 2017 as a whole.

Our non-GAAP net income for the second quarter increased 22% to $7 million or $0.16 per fully diluted share compared to $5.7 million or $0.13 per fully diluted share in the same period last year.

The increase in our net income is consistent with the increase in our revenues and operating profit.

In addition, we have financial income of $200,000 in the second quarter of 2018 compared to financial expenses of approximately $600,000 in the same period last year.

Turning now to the balance sheet.

As of June 30, 2018, cash and cash equivalents, short-term bank deposits and marketable securities amounted to approximately $91.2 million compared to approximately $90.9 million at the end of 2017.

Our total financial debt as of June 30, 2018, amounted to $34.8 million compared to $37.6 million at the end of the first quarter of 2018.

The decrease in our total debt in the second quarter of 2018 resulted from a mix of loan repayment and devaluation of loans, which are denominated in Israeli shekel.

From a cash flow perspective, we generated $8.8 million from operating activities in the second quarter and $16.1 million during the first half of this year.

In our press release issued today, we announced that Magic Software Enterprises Board of Directors has declared a semi-annual cash dividend in the amount of $0.155 per share and in the aggregate amount of approximately $7.6 million for the first half of 2018, reflecting approximately 75% of our net income and 47% of our cash flow from operating activities for the first half of 2018.

In July 12, 2018, we concluded the issuance of 4.3 million shares or 9.5% of our outstanding ordinary shares for an aggregate amount of approximately $35 million based on the price of 8.2 per share from several leading Israeli institution investors and from Formula Systems, our controlling shareholder.

We intend to use the net proceeds of the offering to support our continued organic growth momentum and funding of potential acquisitions.

We are reiterating our 2018 full year revenue guidance, which we expect to be in the range of $283 million to $293 million on a constant currency basis, reflecting an annual growth rate of 10% to 14% year-over-year.

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

Thank you, Asaf.

So in summary, this quarter's strong financial results demonstrate that Magic continues its impressive forward momentum with growth in both revenues and profits.

Our record-breaking first half results for 2018 confirm that our strategic business initiatives are paying off.

We announced new cutting-edge technology in the application development arena, which has a significant competitive edge and is already gaining a great deal of positive interest throughout the industry.

We continue to expand our important partnerships in the fast-growing integration markets.

And we'll continue to invest in our business with new and existing clients as well in our growth areas, including mobile, cloud and big data to deliver increasing value to both our clients and shareholders.

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

(Operator Instructions) The first question is from Tavy Rosner of Barclays.

This is Chris Reimer on for Tavy.

The slight decrease in gross margin this quarter you mentioned was attributable to a customer.

Could you explain that again or give some more color on that?

Yes.

We have a -- one of our largest customers, which has a [gradual] -- has an increasing rebate program.

So based on the amount of revenue that we generate, we can increase the level of rebate that we need to apply over the revenue that we generate.

In 2017, there was a -- sorry, in 2018, there was a 20%, 25% increase in the rebate level that we apply over such revenues due to the increased level of operations that we have with them.

I see.

So this is a onetime thing?

No, it's not a onetime thing.

It depends, again, on the level of operations that we will generate with them.

I think that in this case for the second quarter, as I mentioned, there were also some projects that will -- they're characterized with low margin, which I believe that will not have such a significant impact influencing the second half of the year.

So I expect gross margin to improve.

Okay.

Also, on operating margin, there was a slight increase.

Is there anything driving that?

Or was that just a result of the current operations?

Yes.

Doing two things that basically -- or experienced 2 things that basically impacted our quarterly operating margin.

First of all, we see continuous increase in the sales of the software licenses that we have in the second quarter of 2018.

The increase that we experienced in revenues was 50% related to software license and maintenance and support agreement and the remaining 50% to professional services.

On the other hand, we keep trying to maintain a level of expenses that matches the level of operations that we have today.

And out of several of our activities to offshore -- to our offshore facilities that relates to the R&D, we have a facility in India and one facility in St.

Petersburg, which, of course, lowers our research and development expenses.

Okay.

And one last one, just around your competition.

After the acquisition of MuleSoft, do you see increased competition in your addressable markets?

Practically, we don't really see this competition.

We have still a strong partnership with Salesforce.

And at the beginning, we were quite concerned with this acquisition, but we meet the people in Salesforce.

And currently, it looks like we are not really competing because MuleSoft is targeting like more kind of Tier 1 and Tier 2 customers and we are targeting the SME market.

So currently, it works fine, the opposite meaning we are gaining even more business because of the buzz in the industry.

The next question is from Bhavan Suri of William Blair.

I guess, maybe, Guy, just to start off with a follow-up in the competitive environment.

You guys have always been sort of a low-code development environment before it sort of became sort of now the excitement, the interest in that area.

When you look at sort of that space where you guys have had a niche for a long, long time, are you seeing more from guys like Appian at all in that space or Nintex or some of those folks?

Are you seeing any impact from some of the guys now starting to pick up on that sort of low-code environment space?

Not really.

We see here and there, we see ALT Systems, but not the one that you mentioned.

Yes.

ALT Systems and Appian are the 2 sort of -- the main guys out there.

Interesting.

And then I guess, when you look at the development you just released, new level of xpa, what's driving the growth?

If it's still -- I mean, for a while, it was cloud and integration.

And then mobile had a pretty big impact.

And obviously, we now know native first and mobile first and native apps are working.

What's sort of driving some of the organic growth you guys are seeing today?

Which one of the product sets?

Or is it sort of fairly broad based?

I think it's fairly broad based.

I think the main trigger is that many of our existing customers are starting to develop again based on the new technology that we launched.

And it starts to bring more business.

So before, they were kind of looking for complementary technologies for the development.

Now I think the situation is a bit different.

Got it.

Got it.

And then a follow-up on that, just on the vertical offering.

Telco has been sort of a positive, sometimes negative.

You obviously have a very large telco customer.

Any update on how that engagement is going?

Yes, yes, yes.

I'll let Yuval answer this one.

Sorry, I missed the beginning of your question.

Our customers are [starting to develop] with the new technology.

Okay.

Yes.

So our customer base (inaudible) is amazingly really excited about it, and I feel the feedback on a daily -- the day-to-day business activity that we do with them.

I think also to complement the question that you had before, basically, the biggest incentive that we see here is what we call the digital transformation.

And as we look at digital transformation and as the industry look at digital transformation, it's basically the consumer -- the end-customer digital experience.

This is what our customers need to provide, and this is what we provide to our customers.

And this is something that there have been missing in the last few good years, and now we provide it as well.

As Guy mentioned, they don't need to step outside of our ecosystem.

This is the biggest incentive and the biggest feedback that we get from them at the moment.

Got it, got it.

And then, I guess, let's touch on the Microsoft relationship.

Obviously, if we go back -- gosh, I've covered you guys a while, but let's say 3, 4 years ago, Microsoft was a competitor and sort of it was this partnership that you can still develop, but Microsoft also sort of competing technology.

So Guy or maybe someone in the call, just a little more about sort of the Microsoft relationship?

And I guess, more importantly, what does that mean going forward?

Are you guys co-selling to customers?

Is Microsoft recommending you?

Is it part of Azure?

How should we think about what that relationship may mean, not this year, maybe even not next year, but 2 to 3 years down the road in terms of driving new customers and revenue?

Okay.

So I'll refer first to the competition part.

I think Microsoft is a huge organization, and therefore, they're competing with everyone in some way.

Talking about whether it's in development or being integrated, we've talked -- they're not really competitors.

Here and there, yes, we find them.

Now with relation to the partnership, the goal is, of course, from both sides is to go with Microsoft, use, of course, Azure because this is their interest in return for them to promote us.

And I think they are quite aggressive about it.

And from the discussions, it looks like this is what they want.

They have to be fair, of course.

But we've met some of their partners [that did it with them].

We are learning more and more about them, and it looks like they are quite there.

So hopefully, we'll bring them the right technology and we'll start to push it.

Got it, got it.

And then a couple on the financial front for me -- actually, maybe just one.

On sales and marketing, that came down pretty dramatically (inaudible) your revenue.

I guess first, strategically, Guy, are you thinking about -- sort of when you think about new versus existing customers, you think about the growth, is there a shift in how you're attacking that?

Or was this just sort of a one quarter anomaly versus sort of wrapping up to get new logos?

And then sort of just trying to understand why that ticked down.

First of all, it's a one quarter anomaly.

Basically, we do see an increase in the amount of salespeople that we recruit.

It depends because we have certain amount of royalties agreement that we have, and we made some provision for this agreement in the first quarter based on the level of sales that we saw that we are going to produce this year, then it took a little bit down on the second quarter based on the type of software that we sell.

Other than that, there wasn't any significant impact to the sales and marketing versus last year.

Yes.

I think it's the opposite.

We are pushing more and more towards hiring salespeople.

Do you want to share any sort of plan, Guy, in terms of number of people...

We are struggling like everyone else in the industry because hiring salespeople today, especially in the sales side, I don't have to tell you.

It's a struggle.

It's -- we need to pay them a lot.

And it takes them like at least 3 to 6 months to become kind of effective.

And in 6 months' time, whether they are effective or you need to replace them.

Or someone will hire them for more.

Yes, yes.

Yes.

But we increase the level of the packages that we pay them in order to hire more people.

And we -- it's not yet satisfying, but we have some progress on this one.

The next question is from Kevin Dede of H.C. Wainwright.

Guy, can we dive in a little bit deeper on the Microsoft deal?

Can you give us maybe the amount of time that you've spent with them thus far and how your pipeline has changed?

And specifically, where you think they're looking to leverage your technology?

Okay.

In terms of the time we've spent with them, we think it's probably for the past [3] years.

And I must say that in terms of the pipeline, we are not there yet, meaning we need to do something first in order to go on their platform and then they would start to promote us.

So Yuval, you can give more detail.

I think what we do with the partnership with Microsoft -- and again, Microsoft did a tremendous shift in the last year or so, okay?

They're kind of looking forward and putting behind all their legacy solutions, their database, operating system, et cetera.

Their only vision and only thing that they care about now is cloud, and it's Azure and Azure consumption.

So this is the partnership, the new program -- or partnership program that they started to launch 6 months ago or something like that, okay?

This is what we joined in this session, and this is why competition is not relevant anymore.

And the idea for them is to invest a lot of money in marketing us together with us and other partners, okay, just in the purpose of having more and more end customers consuming Azure services, okay?

This is the only thing that they see in front of their eyes, and this is also why they pay double commission internally, et cetera, okay?

So for now, we are looking just to deploy our technology on their infrastructure in order for new customers that are coming to us to consume Azure services, okay, even if it's indirect, okay?

They don't need to have licenses on Azure.

They can go through us.

And on the same line of thought, we're looking now technology-wise to take more services of Azure and embed them into our technology in order to have a bigger footprint in the Azure playground, okay?

And there, we need to make a decision based on cost efficiency and stuff like that to see if this is the best tool that we really want to push because, as we all know, Microsoft are great, but not all their tools are the best, okay?

So we need to select which tool we want to implement from which platform.

But this is the vision of the partnership.

This is where they're pushing us, and this is where we also see the opportunity, okay?

That really needs to be clear, we are not expecting Microsoft to come up with leads for us.

We are still the one that need to come with the lead, register them at the Microsoft program.

And once we do that, we get from Microsoft the assistance for the focal point in the organization that can help us promote the sale.

And for that first and you get incentivized, as Yuval mentioned, and that's the shift.

Also part of the program that they have is partner to partner, what they call.

That means if they have a one partner solution that they identify that we can actually be complementary to a solution, they will push it to us in order to cooperate together, okay?

And this is one big advantage that we see there.

Okay.

So that helps a lot, right?

So really, it's about working and leveraging their Azure cloud platform.

No, not only the Azure, also the other partners.

Just in the last conference, they introduced us to like 100 of their partners that they believe we can join forces with in order to sell our integration platform.

Okay.

Do you have a view -- I mean, clearly, you see the competitive environment change at least within the Microsoft partnership arena.

But do you have a view to others that might have a comprehensive integration package, as you do, that addresses the SME market?

Or do you think you're -- at this point, do you think you're pretty much exclusive there?

I think at this point, we don't see that much competition.

It's between the high end, where you see MuleSoft or, I don't know, Informatica or maybe even Dell Boomi.

The low end, where you see all the cloud solution -- the pure cloud solution that you just plug and play some simple integration solutions.

And at the mid-level, I think you don't have that much competition.

On the other hand, talking about whether it's Microsoft or whether it's other ecosystems that we can use, we are trying everything.

We are pushing all the time.

This company is growing like, I don't know, 20% average every year, improving all the time.

So probably, if something is -- will [boost], then we'll be very happy, of course.

But it's not that we now -- we stopped everything and we count only on Microsoft.

We continue to...

Yes -- no, no, no.

Yes, obviously, clearly, I understand that.

I guess what's interesting is just sort of the dynamic nature of the software business and how prevalent cloud services have become.

You guys have been working really hard.

And to be able to forge this relationship with them, I think especially given the way that their business is changing, I think that put you in a good position.

Exactly.

This is why we see the potential.

Because Microsoft became very aggressive changing their business model.

Okay.

So that begs -- it begs the obvious question, given the rise of Amazon AWS, what can you talk to about working with them potentially or IBM?

And as you see these major companies starting to push their cloud services, clearly, they're all looking at each other trying to figure out how to grab as much market share as possible.

What's your strategy there?

And what could you talk to?

So at the end of the day, as you mentioned, there are at least 3 big players.

If I put IBM as well, there are 4. But -- and this is what I said before, if I'm going to select the Azure solution for a specific scenario or not.

I'm not -- we are not going to commit fully to Microsoft to be exclusively Microsoft, okay?

Unless at the end of the day we'll see that it's really, really having a huge impact on the numbers, okay?

I think our model at the moment is really trying to move as much as being a cloud-agnostic but to cooperate with everyone.

By the way, they are doing it, okay?

If you look at Microsoft, Microsoft and Google are doing an amazing cooperation around (inaudible), okay?

So why do I need to select one of the 2, okay?

I want to play with the 2 -- with both of them, okay?

So this is the constant that we are looking at.

The fact that we are not going to exclusively commit to anyone, we're trying to be cloud-agnostic as much as we can, okay, and offer, at the end of the day, not software, but more solutions and moving from just selling pure licenses, as we did so far, to work with partners and with existing customers to offer solutions around our tools and infrastructures.

I want to say one more thing, that -- talking about the 3 main ones in this cloud area, Microsoft, I think, is way more solid in terms of the potential partners or clients that they have for our integration platform because they have the dynamics, they handle kind of other developments companies did with their platform.

So they are this more mature if you compare them to Google or...

AWS.

AWS.

And you can add to this one that AWS [has] Amazon, they do have quite huge community that will never step into AWS because of the Amazon platform, okay?

Not technology, but because like a Kmart or all the other competitors that are competing on this market, okay, will go immediately to Azure and not to AWS.

So this is opening a new market or a full addressable market from our point.

So there is also this kind of negative relationship for Amazon because they're coming with 2 hats, with the technology and their Amazon store.

All right.

Interesting point.

Okay.

If we're going to go back and look at your own R&D and tool development, the latest version of xpa 4 has angular capabilities included.

And I guess I was hoping you could take a step back, maybe just look from the 20,000-foot perspective and give us a feeling for where you see the largest demand for technology.

Given your agnostic-cloud position, but leaning more toward Microsoft, given their entrenched position in the enterprise, just maybe help us understand how you see demand for your tools and how you're using R&D to meet that.

Okay.

We see it basically in the trends of what's happening in the web environment -- web development environment, okay?

And if we look a little bit -- take it a few more years back, if you look at the web development environment, when we started web in the '90s, a website with 1 line -- 1,000 line of codes was considered to be a big website.

But over the years, we added, from the technology point of view, [Uplift] and Ajax and stuff like that and we slowly, slowly moved to a more complex web applications, okay?

I think the one that made a tremendous change is the fact that JavaScript, in the last 3 years, just actually won the game, okay?

3 years ago, 5 years ago, we had the negotiation, do we go for mobile, for instance, native or HTML5?

This fight is won, okay?

And JavaScript is actually the most common development language in our day.

But the problem is that JavaScript is unmaintainable, okay?

So it's not scalable.

You cannot really write 1 million lines of code application using JavaScript.

This is also why you see in the market Microsoft came up with TypeScript, okay?

This is a type safe way of writing JavaScript, et cetera.

And this is also why you see frameworks like Angular, like Vue, like React are being adopted more and more because the vision behind them is actually to make life easier for the developer.

And as you mentioned before -- one of you guys, that this is what we've been doing for the last 35 years, okay?

This is our philosophy and paradigm over the -- over all years, just make life simpler for developers, okay?

Now we're kind of catching up on the new wave and [riding] with our philosophy using the new technology, okay?

So this is where we see the most adaptation, that people want to do amazing look and feel application, but they don't want to write millions lines of code and try to maintain them.

Okay.

That's a great backdrop.

But could you just take it one step further and give us greater insight on where you're really seeing that pull?

Is it specifically in just web development?

Are you seeing more -- I guess, could you just talk to it with relation to mobile and integration in general?

Again, the concept, and this is what I mentioned before, the digital transformation, the fact that anybody is looking to give a digital experience to his customer, okay?

That means that tons of new small and big application and exposing existing business functionality that you have today.

If I'll take the bank, for example, so the bank is working with computers for 50 years.

And the fact that I can put a check into my bank, that's no problem.

But the fact that I can take now a check and just use it from my mobile and take a picture and then deposit into my bank account, this is the digital experience that the consumer are expecting today.

And this is the big bank that we're seeing now from everybody, small and big customers, this is what they need, and they need to do it fast.

So this is where -- and by the way, it's combined with integration because, at the end of the day, when I take my camera on my phone and take a picture of my check and want to put it into my bank account, at the end of the day, do need to go to the mainframe, okay?

So there is a full process including integration there.

And we try to enjoy from both light.

It doesn't have to be together.

It can be either the integration, either the mobile or both of them, but this is the big pie that we're trying to take as big a chance as we can.

Okay.

Last question from me, just to change gears a little bit.

Still a very heavy cash balance.

I know you guys have been concerned on valuations.

Given this big focus on development and matching the way technology has been changing with the Microsoft deal, can you talk a little bit to your pipeline, how much attention it's getting, especially in light of this recent deal -- stock deal, that is, the stock sale?

Yes, okay.

So we had the stock deal.

Before that, we were really close to finalize an acquisition.

Unfortunately, we felt that it's a bit risky in terms of the results that they've shown us just before the signing.

So we decided to wait a bit and either improve the terms or postpone it, the transaction, and catch up like in a few months and see what will improve.

So this is the story behind it.

We were just about to close it and it was not doing that great.

Okay.

Fair enough.

Anything else on the horizon that you can speak to?

Have valuations changed?

Are you perhaps looking at technology now that can enhance your cloud capability?

Any other color?

We look for things all the time, whether it's technology companies or unique service-oriented companies.

We have some in the pipe, not something that is worth mentioning at this point.

(Operator Instructions)

There are no further questions at this time.

Mr. Bernstein, would you like to make your concluding statements?

Yes.

Thank you very much for joining us on this call today and we sure hope to bring you more good news in the next quarter.

Thank you.

Thank you.

This concludes the Magic Software Enterprises Ltd.

Second Quarter 2018 Results Conference Call.

Thank you for your participation.

You may go ahead and disconnect.