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Edited Transcript of MGIC.TA earnings conference call or presentation 13-Aug-19 2:00pm GMT

Q2 2019 Magic Software Enterprises Ltd Earnings Call

Or Yehuda Sep 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Magic Software Enterprises Ltd earnings conference call or presentation Tuesday, August 13, 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

* Yuval Lavi

Magic Software Enterprises Ltd. - VP of Technology & Innovation

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Conference Call Participants

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* Kevin Darryl Dede

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Tavy Rosner

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

* Theodore Riley Starck-King

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

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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 Magic Software Enterprises 2019 Second Quarter Financial Results Conference Call. (Operator Instructions) With us online today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's 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.

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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 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 a GAAP versus non-GAAP result has been provided in a 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 -- on the company's website.

I will now turn the conference over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [3]

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Good morning, everyone, and thank you for joining us today as we report our second quarter 2019 financial results. Our second quarter revenues totaled $77.1 million compared to $70.2 million for the second quarter last year and $71.8 million in the previous quarter, reflecting 10% and 7% growth, respectively.

During the second quarter, we experienced fewer working days due to the Jewish Passover, the Israeli Independence Day, international election day. We are proud to conclude our quarterly and half year results with continued growth across all our major financial indices. These results serve as a testimony to the solid execution of our well-defined corporate strategy.

In addition, and as we indicated during our first quarter investors call, we continue to experience in this quarter a certain decline in our business activity with CVS. Such decline was compensated with new projects provided specifically to existing clients.

Though our full year 2019 guidance did not factor this decline in business with CVS, we still remain confident in our ability to achieve our full year 2019 guidance, which now factors an incremental impact from M&A based on our foreign deal backlog as we are on final stages to acquire a U.S.-based software service company.

Looking at the geographical breakdown of our revenues. During the second quarter, North America accounted for 48% of our total revenue; Israel, 36%; Europe, 9%; and APAC and the rest of the world accounted for 7% of our annual revenue. Most of our growth in 2019 is in absolute numbers, was traditionally for North America and Israel, which continued to be our strongest territories. North America accounted for 53% of our growth and Israel for 27%.

Turning now to profitability. Our non-GAAP gross profit for the second quarter of 2019 was $25.9 million, up approximately 11% compared to $23.4 million in the second quarter of last year. Our non-GAAP gross margin increased to 33.7% compared to 33.4% in the second quarter of last year. The breakdown of our revenue mix for the first half of 2019 was approximately 28% related to our software solution and 72% related to our professional services, same as 2018 as a whole. The breakdown of our gross profit mix for the first half of 2019 was approximately 52% related to our software solution and 48% related to our professional services compared to 54% related to our software solution and 46% related to our professional services in the respective period. Our solid performance continued to be driven by the increasing demand for our diverse portfolio of innovative software solution and professional services evidenced by our ever-expanding base of new customers and strategic partnership with major organization and ecosystems.

Moving to operational costs. R&D expenses on a non-GAAP basis in the second quarter of 2019 totaled $3.1 million compared to $2.7 million in the same quarter of last year. The increase in our R&D expenses related mainly to the first-time consolidation of PowWow.

As evidenced in many other software development companies in recent years, Magic has also been moving its development efforts to India and opened a new R&D center in St. Petersburg to support its growing base of global customers. These centers are aimed to help us drive innovation and provide support for new existing projects across our product portfolio, providing scale to our organization with an efficient cost structure and is critical to support our future growth.

Our non-GAAP operating income for the second quarter increased 9% to $10.7 million compared to $9.8 million in the same period last year. This reflects an operating margin of 13.9% for this quarter compared to 14% in the second quarter of 2019 and in the first quarter of 2019.

Our operating income for the second quarter included the first-time consolidation of PowWow, our recent acquisition and the creator of SmartUX, a rapid low code development platform, which was completed on April 1. As we indicated on the announcement of the deal, PowWow is not expected to be accretive to our results during the first 12 to 18 months, following additional investments in opening new markets as well as intensive sales and marketing efforts.

Our non-GAAP tax expenses this quarter totaled $2 million compared to a tax expense of $1.6 million in the second quarter of 2018. Our effective tax rate for the first half of 2019 was approximately 18% compared to 19% for the first half of 2018. We estimated that our effective tax rate for the full year of 2019 will range between 19% and 21%.

Our non-GAAP net income for the second quarter increased 1% to $7.1 million or $0.14 per fully diluted share compared to $7 million or $0.16 per fully diluted share in the same period last year. Earnings per share for the second quarter of 2019 were negatively impacted by an amount of $0.014 per fully diluted share compared to the same period last year, resulting from the company's private placement of 4.3 million shares to Israeli institutional investors concluded on the third quarter of 2018.

Turning now to the balance sheet. As of June 30, 2019, cash and cash equivalents, short-term bank deposits and marketable securities amounted to approximately $160 million compared to approximately $116 million at the end of 2018. Our total financial debt as of June 30 amounted to $29 million. From a cash flow perspective, we generated $15.9 million from operating activities in the second quarter and $26.6 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 semiannual cash dividend in the amount of $0.156 per share in the aggregate amount of approximately $7.6 million for the first half of 2019, reflecting approximately 75% of our net income and 30% of our cash flow from operating activities for the first half of 2019.

In summary, this quarter's core financial results demonstrate that Magic is continuing its impressive forward momentum with growth in both revenues and profit. Our record-breaking first half results for 2019 confirmed that our strategic business initiatives are paying off.

On the M&A front, we continued with our effort to find potential companies that fit our strategy and our valuation range. We are currently looking for small to midsized companies with revenues in the range of $20 million to $50 million, which will follow our strategy, geographic expansion, complementary products and customer base.

With that, I will now 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 Maggie Nolan of William Blair.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [2]

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This is Ted on for Maggie. So I wanted to ask about the PowWow acquisition and just wanted to get your sense for how that performed this quarter compared to your expectations.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [3]

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I think that basically, as we said, we initiated this transaction as we believe that a mobile development application platform are something that are in extreme demand in today's legacy...

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Yuval Lavi, Magic Software Enterprises Ltd. - VP of Technology & Innovation [4]

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Legacy transformation.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [5]

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Exactly. In today's legacy transformation in enterprises. Our results did include 1 transaction that we work for, for a term license with a significant financial institution in the U.S. for a 3-year term for approximately a total deal value of $800,000. So for us, it's another evidence of the benefit that companies can and enterprises can generate from such a platform.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [6]

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Understood. And so then in thinking about for the full year, do you have an idea? Or how should we think about the contributions from PowWow for the full year of 2019?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [7]

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Basically, we currently believe that for the remaining of the year, we are supposed to because a lot of something that we did between $500,000 to $1 million for the second half of the year.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [8]

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Okay. So then on the revenue line item, is there any need for contribution there that we should be thinking about?

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

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I don't think that it is -- it's not material in the sense of the actual type of operation that we have today. Still like few million of dollars in opposed to the $80 million that we are currently doing, $80-plus million.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [10]

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Understood. So I want to switch gears here to the CVS, Aetna relationship. I know you mentioned that there is still some softness this quarter. I kind of wanted to -- hopefully you could break apart and distill for us the performance this quarter, how much CVS weighed on your revenue results. But also at the same time, how much contribution do you then get from new sources of revenue?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [11]

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Basically, for this quarter, CVS accounted for around 13% -- close to 15% of our revenues, but still it's a -- on a run rate term, if you compare it to the previous year for the previous half year, we are down $5 million in terms of revenues from CVS.

I can tell you that going into August, we saw a stop in the decline, and we are at and we are again receiving projects, new projects and getting new people, additional workforce in CVS. So currently, I don't expect this decline to continue. But on the current run rate versus the 2018, we are expected to be down $10 million in terms of total revenues between 2019 and 2018.

On the other hand, we managed to pick up significant projects in the U.S. and also in Israel with existing customers. We signed a new project in Azerbaijan for a cyber and command-and-control center, so -- which is a much higher gross profit than the one that we lost with CVS. So all in all, this is why, although we are losing like $10 million in terms of annual revenues from CVS, we still manage to maintain our profitability and even improve our gross profit.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [12]

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Great. That's very helpful color. Wanted to clarify real quick. So you said that CVS, you're starting in August here to see a turnaround in the spending in that account.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [13]

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Yes.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [14]

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All right. And then last question for me and then I can hop back into the line. So over the last year or so, the adjusted operating margin is between like 13.8% and 14%. How does that range kind of compare to your expectations for the business in the medium and long term?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [15]

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I think that based on the level of operations that we have today, and as I said including the expected acquisitions that we are closing during the third quarter for a software service company, I think that we are supposed to remain in the range of the 13% to 15% -- 14%, I'm sorry, to 15% operating margins.

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Theodore Riley Starck-King, William Blair & Company L.L.C., Research Division - Associate [16]

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So that was 14% to 15%?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [17]

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Yes.

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Operator [18]

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Your next question is from Tavy Rosner of Barclays.

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Tavy Rosner, Barclays Bank PLC, Research Division - Head of Israel Equities Research [19]

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You guys mentioned your efforts on the offshore R&D side. I was wondering, can you elaborate a little bit about what's your presence today? You mentioned St. Petersburg and India. And is it too early to quantify any potential uplift to margins down the road thanks to that?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [20]

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We have today approximately 120 employees in India. We aim to increase that amount to up to 150. Again, we're not saying that amount is also for R&D, internal R&D work that we have and also for professional services and delivery in projects that we are doing to customers around the world. In fact, [in this group] we have around 150 employees today. Most of them are in the field of delivery, doing projects mainly to customers in the U.S. today and around -- I would say, out of them, around 40 are engaging R&D -- in R&D activities.

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Tavy Rosner, Barclays Bank PLC, Research Division - Head of Israel Equities Research [21]

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Got it. And with regards to margin, do you think that structurally, as you develop these offshore capabilities that, that should be boosting your structural operating margin?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [22]

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Probably it will improve margins, but we are talking about small numbers.

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Tavy Rosner, Barclays Bank PLC, Research Division - Head of Israel Equities Research [23]

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Got it. That's helpful. And maybe just a quick one. One of the press release I caught was about FactoryEye that you guys are really focusing on the legacy IT system. I mean how big is this end market, if you could quantify?

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Yuval Lavi, Magic Software Enterprises Ltd. - VP of Technology & Innovation [24]

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This market is huge, but as any of our technology market, it's segregated into different segments and businesses. Like if you say IoT, how big is the market of IoT? So there is basically no limit.

But we are focusing on a subsegment of the market for the mid-level manufacturing that cannot really go and buy the high-end solutions and want to stay with existing technology but to increase functionality and operational cost improving. And this is where we come with the solution of FactoryEye that combines our existing technology like Magic xpi, other technology of analytics and stuff like that and some expertise that we brought in from the manufacturing world. So this is our segment of the market that we are focusing on.

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Operator [25]

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

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [26]

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Asaf, you mentioned that $800,000 through your deal financial institutions U.S., is that the excess or [powers one] that you announced during the quarter?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [27]

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Again, the question? I understand the $800,000. I didn't understood the end of your question.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [28]

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Yes. I'm sorry, Asaf. You did mention one deal came in from a financial institution in the U.S., but you also announced one in the press release during the quarter. I was just wondering if they were the same.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [29]

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No, no, no.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [30]

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Oh, okay. All right. So Yuval, you talked a little bit about FactoryEye. Are there solutions there that aren't available from some of the larger software vendors? Anything that is specific to what a mid-tier manufacturer might need?

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Yuval Lavi, Magic Software Enterprises Ltd. - VP of Technology & Innovation [31]

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Again, they are the ones that target the manufacturing like Daimler or who knows, companies like that, which is really going to end to end, improving performance and efficiency in the factory. Okay? So we are not trying or we are not aiming to compete with those. We're coming to projects, which are in the like $50,000 and above with [PS] and stuff like that, not to the million, the $2 million, $3 million projects, okay? So we're kind of trying to put ourselves in a separate focus of the market.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [32]

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Okay. What sort of demand have you seen? And was your interest in developing this for a specific customer? Or have you had this request for many?

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Yuval Lavi, Magic Software Enterprises Ltd. - VP of Technology & Innovation [33]

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What we effectively did, we went internal with our SWOT analysis. In general, we found out that we have quite a lot of customers in the manufacturing arena already that are using our technology. This in the North America under Oracle JD Edwards technology that we have a good partnership there. So we found out that we already in this domain already.

And then we saw the need of, again, analytics and some kind of machine learning and a little bit of the IoT that all of us are in this technology arena are looking at. And within that, we came up with the niche that actually covered this quite well. Okay. So that was the incentive and this is the treatment also that we get from the market at the moment. We have a lot of interest. It's kind of only the beginning, I would say, the first 6 months of this launch of this full suite of a solution, but the interest is quite strong all around us.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [34]

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So in U.S., we're hearing a lot about economic, I guess, sort of a slowdown in Europe and sort of seems that your results reflect that a little bit. I was just wondering if maybe you could talk to sort of the global picture. Granted, lots of strength in North America and Israel, but is there any more granularity you can add about the specifics to Europe and maybe South America and other geographies?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [35]

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It seems that in South America, we have a limited amount of business today. Europe is pretty stable. We had a good year last year. We had also significant transaction with another financial institution last year that was announced for 5 years, the term license agreement that we announced last year. So last year, Europe was pretty high.

Today, I think that they are stable. We have a strong belief in our potential in the Japanese market, both in the integration arena and both in the software development application, also with the opportunity of the SmartUX. But this is part of the reason why we say that we still need to invest in expanding our sales capability, our marketing capabilities and the localization of the SmartUX also to the Japanese market.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [36]

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Okay. Just a question on the CVS deal. Is that leading at all to maybe an interface with Aetna at all? I'm wondering if maybe those folks see how you've helped CVS, that maybe they'd ask you to help them on certain projects.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [37]

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This is the basic idea, and this is also our expectations. I think that for the meantime, it seems that I think CVS and Aetna are in the -- still in the processing of -- on what should be done in their side and once we will decide how to go with, I'm sure that we will hopefully also benefit from that decision. This is still our basis -- basic assumption. But again, as I said, we managed to compensate for the loss that we currently have from CVS with other projects that we believe even can provide us with higher gross profits.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [38]

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And Asaf, could you just go over your guidance again? You said it was still $313 million to $319 million.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [39]

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It's the same. Yes, it's the same, and as we said, the difference is that we originally did not incorporate the decline in the CVS. I think that we will -- again, based on the current level of operations that we have today, we'd still manage -- and the fact that we managed to compensate that, we'd still manage to meet that guidance.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [40]

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Okay. All right. The -- I know you mentioned a few days of the quarter were shorter. Was it just 3 days shorter than, say, the March quarter? Or I mean, I know there are a lot of holidays that come up in September, too. So just could you put it in relative framework?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [41]

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It's 6% lower than the previous quarter.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [42]

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Okay. Then last question on just the M&A outlook. You mentioned that you're close to a deal. Is that the way to consider it?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [43]

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Yes. We are pretty close to close the deal, yes.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [44]

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Okay. Will that get a separate press announcement once that happens? Does that merit that or...

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [45]

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Yes.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [46]

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Okay. Is that something you expect to happen this quarter or maybe fourth quarter?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [47]

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We expect it to happen this quarter.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [48]

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Okay. Then how does the pipeline look beyond this big deal coming up?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [49]

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I guess we have quite few opportunities, but none of them is in a stage that I can say we can -- we are able to close. In most cases, they don't fall into our price range for all kinds of reasons. In some of them, we proceed with the diligence and hopefully, we'll be able to close them.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [50]

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No, I understand the careful analysis. I'm wondering though, over time, don't some of these operators realize that the operating conditions only become more difficult for them and then they might be willing to consider an arrangement that you would see as more attractive?

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [51]

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I'd say, over time, everything is becoming more and more expensive. People tend to get money easily. And as a result, of course, all the assets are -- all the prices are going up. And at the end, in cases where we compete with a private equity fund, it's very hard for us to compete with them.

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [52]

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When you are going to a company and they are doing any certain amount of profit and they're saying, "Okay, we are doing this amount, and we look at Magic and they don't even take into consideration the -- let's say, the cash that I have in my balance sheet, so your valuation in comparison to your EBITDA is around a multiple of 10. So we expect a multiple of 10." They are like a very small business with -- many sometimes have significant customers factored in, and their expectations are still through the roof.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [53]

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I understand. All right. If that's the case, Asaf, then does it still make sense to carry as much debt on the balance sheet as you are given your high cash balance and the fact that you're generating so much cash?

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Asaf Berenstin, Magic Software Enterprises Ltd. - CFO [54]

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Again, as I said, we are continuing to look for companies. As we indicated, we are going to close the deal in the, say, the third quarter. We are continuing to be on the lookout. Sometimes, you are dealing with sellers that when you are in the process of the negotiation, they don't seem to really want to sell, just getting -- just falling in love in the process of negotiating. So I think that this company knows how to do transaction. We did over 25 deals during the last 10 years. We are trying to, again, get on the saddle again and do the deals the way that we want -- the way that we used to do. I hope that this deal will open again the floor for us, but I want the company...

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [55]

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Yes, I didn't mean my question to imply that you guys didn't know how to execute on that. That wasn't it at all. It just seemed to me that...

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Guy Bernstein, Magic Software Enterprises Ltd. - CEO & Director [56]

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No. With regards to the deal and talking about relating to the debt, the interest is very low, so we can close it if we want. We don't see it as an issue.

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Operator [57]

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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 [58]

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Thank you for joining our call, and we hope to bring you some good news in the very near future. Thank you.

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Operator [59]

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