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Edited Transcript of MGIC.TA earnings conference call or presentation 16-May-19 2:00pm GMT

Q1 2019 Magic Software Enterprises Ltd Earnings Call

Or Yehuda Jun 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Magic Software Enterprises Ltd earnings conference call or presentation Thursday, May 16, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amit Birk

Magic Software Enterprises Ltd. - VP of Mergers & Acquisitions, General Counsel & Corporate Secretary

* Asaf Berenstin

Magic Software Enterprises Ltd. - CFO

* Guy Bernstein

Magic Software Enterprises Ltd. - CEO & Director

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Conference Call Participants

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* Margaret Marie Niesen Nolan

William Blair & Company L.L.C., Research Division - Analyst

* Tavy Rosner

Barclays Bank PLC, Research Division - Head of Israel Equities Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Ltd. 2019 First 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 would now like to turn the conference over to Mr. Amit Birk of Magic Software. Please go ahead.

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Amit Birk, Magic Software Enterprises Ltd. - VP of Mergers & Acquisitions, General Counsel & Corporate Secretary [2]

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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 views or expectations or otherwise.

Also during the course of today's call we will refer to non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in the press release issued before the markets 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 call over to Mr. Guy Bernstein, CEO of Magic Software. Please go ahead.

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [3]

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Thank you, Amit. Good morning, everyone, and thank you for joining us today as we report our first quarter 2019 financial results.

We are pleased to report another good start for the year as we continue our forward momentum with consistent year-over-year growth in the revenues, operating income and net income, which demonstrates the solid execution of our corporate strategy.

Our first quarter revenues increased 3% to $71.8 million compared to $69.7 million in the same period last year. Non-GAAP operating income increased 4% year-over-year to $10.1 million for the quarter.

We continued strengthening our competitive advantages to support our future growth as we reported the acquisition of PowWow SmartUX, a leading low-code development platform for mobilizing and modernizing enterprise apps, which is strongly synergetic to the technology and paradigm of Magic's Low Code existing solutions. By combining them together, we will be able to offer to new and existing clients solutions and services, which better meet today's high demand to complete transformation to a digital workplace.

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

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [4]

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Thank you, Guy. Good morning, everyone. Our first quarter revenues totaled $71.8 million compared to $69.7 million for the first quarter last year, reflecting 3% year-over-year growth. Looking at the geographical breakdown of our overall revenues, North America accounted for 48% of total revenues; Israel, 39%; Europe, 8%; and APAC and the rest of the world accounted for 5% of our annual revenue. Most of our growth in the first quarter [and the] absolute number was from Israel.

Turning now to profitability. Our non-GAAP gross profit for the first quarter of 2019 was $23.6 million, down approximately 4% compared to $24.6 million in the first quarter of last year and up 1% compared to $23.4 million in the previous quarter of 2018. Our non-GAAP gross margin decreased to 32.9% compared to 35.2% in the first quarter of last year, an increase compared to 32.4% in the previous quarter.

The decrease in the gross margin compared to the first quarter of last year resulted mainly from the shift in our revenue mix from software to more professional services, as professional services accounted for 85% of 2018 growth.

The breakdown of our revenue mix for the first quarter of 2019 was 26% related to our software solutions and 74% related to our professional services versus 28% software solutions and 72% professional services in 2018 as a whole.

Research and development expenses on a non-GAAP basis in the first quarter of 2019 totaled $2.5 million compared to $2.3 million in the same quarter of last year. Our non-GAAP operating income for the first quarter increased 4% to $10.1 million compared to $9.7 million in the same period of last year. This reflects an operating margin of 14%, same as in the first and the fourth quarter of 2018.

Our non-GAAP tax expenses this quarter totaled $1.7 million, representing an effective tax rate of approximately 17% compared to a tax expense of $2.2 million in the first quarter of 2018, reflecting an effective tax rate of 22%. We expect our full year 2019 tax rate to be slightly higher in the range of 19%, up to 21%.

Our non-GAAP net income for the first quarter increased 8% to $6.7 million or $0.14 per fully diluted share compared to $6.2 million or $0.14 per fully diluted share in the same period last year. The increase in our net income is consistent with the above-mentioned increases in our revenues and operating profit.

Our earnings per share for the first quarter compared to the first quarter of 2018 was negatively impacted by an amount of $0.013 per fully diluted share, resulting from the private issuance of 4.3 million shares we concluded on the third quarter of 2018.

Turning now to the balance sheet. As of March 31, 2019, we have cash and cash equivalents, short and long-term bank deposits and marketable securities of approximately $109 million compared to approximately $116 million at the end of 2018.

The decrease is mainly attributable to cash dividend paid during the first quarter in the amount of $0.15 per share and in the aggregate amount of approximately $7.3 million for the second half of 2018, which reflected dividend yield of approximately 3.1% and the remaining decline resulting from M&A.

Our total financial debt as of December 31, 2018, amounted to approximately $28 million, same as at the end of this quarter. From a cash flow perspective, we generated $10.7 million from operating activities in the first quarter.

Lastly, with respect to our balance sheet, this quarter we implemented for the first time a new accounting standard ASC 842, which requires us to present future commitments under lease agreements against assets in order to represent our right to use such assets. While there is an impact on our balance sheet in the form of assets versus liabilities, there is no such impact on our P&L.

I would like to turn now to our guidance for 2019. Looking out to the remainder of 2019, we remain confident in our ability to achieve our full year 2019 guidance. As a result, I would like to reiterate our 2019 full year revenue guidance, which we expect to be in the range of $313 million to $330 million (sic) [$319 million] on a constant currency basis, reflecting an annual growth rate of 10% to 12%. In accordance we expect to see incremental revenue growth throughout the remainder of the year.

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

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [5]

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Thank you, Asaf. In summary, we are pleased to witness that the strong momentum for 2018 continued to 2019. We continue to remain focused on preserving and expanding our customer base by constantly developing, evolving and enriching our products and services portfolio with diverse, powerful and innovative technologies, which comply with the requirement of organizations to complete the transformation to digital workplace.

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

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Questions and Answers

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Operator [1]

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

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Tavy Rosner, Barclays Bank PLC, Research Division - Head of Israel Equities Research [2]

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I was wondering if you could elaborate a little bit on your PowWow acquisition. You talked about synergies, can you give more color on what they are? And also I believe that in the press release you mentioned that you would become accretive within 18 months, so can you also give some color, what's going to happen in terms of investment in the company and things like that?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [3]

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Okay, fine. Well, I'll talk to you a little bit about the synergy and how we see it, and maybe then the numbers Asaf can add some things. But as far as synergy, we're looking synergy in two level. First the -- or the two of them, so first and second. But technology-wise and paradigm and methodology and go-to-market, et cetera.

So obviously, when we talk about low-code paradigm, we all know that Magic started 35 years ago with the low-code and all our customer -- existing customer are expecting us to provide the concept of low-code.

So synergy as far as organization, methodology, sales people, communicating the added value, et cetera, is already there by definition.

Technology synergy, Magic in the last 2 years we developed our Web client and Angular solution, which transformed our legacy Magic engine to be able to run on the mobile, but we kind of left behind the user experience build up or how we create the screens and how we create the front end. And this is where PowWow actually put in the most force. And PowWow is coming with an amazing studio that is focusing mainly on the user experience and then going back to the logic technology behind and connectivity.

So the 2 products are actually synced technology-wise as well. Of course, we will have to invest some effort in the next 12 months to do the technology because it's 2 different technology specs. But (inaudible) has a lot of good symbiosing relationship between them.

And we are going to take the PowWow platform and do localization and bring it into our existing branches all around the world like Japanese market as we are quite strong there, but as we know we need localization, we need studio in Japanese, we need to communicate it with a Japanese company in order to sell in Japan. So synergy is strong in all aspects, okay? Do you want to talk about price effectiveness on the incomes?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [4]

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As we've said, I think that basically, this is still a -- as Yuval probably also said, it's still a young platform in order to take it and put it out for sale. We are anticipating investments in marketing to make it available as a download version for developers to start and have something that they -- basic tools that they can start working with.

We are still analyzing the investment or the business plan that we want to come up or the pricing models that we think would best used to address this platform as the cost model that we are applying is a subscription mode. Which is why at the beginning revenues are considered low and then as you [pro] the service, it kind of builds up one over the other, and then you get a significant stack of inflow coming in.

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Tavy Rosner, Barclays Bank PLC, Research Division - Head of Israel Equities Research [5]

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Yes. That's super helpful. And maybe just a quick one. I mean, revenues decelerated a little bit during the quarter, but yet you maintain the guidance for year-end. So is that a question of just timing of recognition?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [6]

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It's not a question of timing of recognition. I think that 2018 was a very strong year. It began very strong since January, basically. In Q1 2019, we had -- versus the end of Q4, we had some slowdown in the sale of the technology, which is something that we always experience between ending of one year and the beginning of another year, with companies closing their budget and doing all of their -- accumulating the acquisition at the end of the year. We increased our headcount for professional services by approximately 150 people during the first quarter, which also something that explains the decrease or the decline that we have in our gross profit for Q1. And in terms of the growth, 2019 didn't start as strong as we expected it for the first quarter, but from the second quarter we already see the improvement, especially on our professional service side and also on the sale of the software.

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Operator [7]

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The next question is from Maggie Nolan, William Blair.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [8]

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I wanted to dig into that last comment that you just made. You're seeing an improvement on the professional services side. So as you continue to see that mix of professional services kind of tick up, obviously that put some pressure on gross margin this quarter, maybe it'll pressure gross margin in future quarters, but your operating margin did hold up pretty well. So as we see that mix trend upward a little bit, what are the some of the levers that you can pull to keep a more stable operating margin profile?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [9]

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I think that -- first of all, I want to say that Q1 gross profit is not something that represent our core gross margin. If you see -- if you look at our numbers in Q1 of 2018 was around 35%. We are now consistently Q2 through Q1 of -- Q2 '18 through Q1 2019 show a consistent 33% of gross profit. We don't expect the gross profit to a decline from this level of the 32%, 33%.

In terms of the keeping our gross profit intact, I think that out of the 150 people that we hired, most of the hiring that we did were at our St. Petersburg location. I can tell you that 2 years ago, we had approximately 40 people in our St. Petersburg location. Now we have close to 200 people that provide offshore services to customers, mainly in the U.S.

And with that, this is how we seeing that we can maintain the level of gross margin that we show today. And on the other hand we also expect to see improvement in the sale of technology going forward with the addition of PowWow.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [10]

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Okay, understood. And then when we're thinking about the guidance range and the start to the year, as we look at kind of how the rest of the year is going to play out, what would it take to get to the high end of that guidance range?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [11]

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Hard work and luck.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [12]

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There a particular buildup in the pipeline, things you're hoping to convert, is that looking strong, and kind of playing into the high end of the guidance, or is there any color you can give there?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [13]

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We are quite -- we have a few big customers that we expect them to grow, especially when we talk about the pharmaceutical industry, the merger between CVS and Aetna. I think part of the reason that we were a bit slow in this quarter is because we estimated that we will get a lot more work from CVS. We see first time it starts to move, but at the end you are dependent on big giant that sometimes it takes them a bit more time, although they give you their projections, and sometimes they are a bit behind. But all in all, we got some new names, and we believe we can meet the guidance.

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [14]

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Okay. That's helpful. And then thinking about PowWow and some of the investments that you were just talking about in the previous question, so is this something that's going to be dilutive to 2019? And what would that impact be compared to 2018?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [15]

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In terms of what?

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Margaret Marie Niesen Nolan, William Blair & Company L.L.C., Research Division - Analyst [16]

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The bottom line. Is it going to be dilutive to EPS, just given some of the investments?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [17]

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Possibly it will have some negative effect on the EPS. I don't think it's going to be dramatic, and we are working to overcome this through some efficiencies in our operations. All in all, we think that the investment is a good one for us, especially due to the synergies and the fact that it's a shortcut to our customers and to new customers. And after all, it's kind of a start-up. So although they have some customers running, it is still very young company.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [18]

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I think that basically also the fact that we are relying on a subscription model for the sale of the software, this is something that also one of the main reasons why there is a -- why this company is not accretive to our results. If you ask me on the guidance of the impact on the EPS, it can earn something between the $0.02 to the $0.04 per share negative impact.

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Operator [19]

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

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [20]

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Yes. Thank you very much for joining us for this call, and hope to see you in our next call and bring you some more good news. Thank you.

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Operator [21]

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Thank you. This concludes the Magic Software Enterprises Ltd. First Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.