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Magic Software Enterprises Ltd (MGIC) Q1 2019 Earnings Call Transcript

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Magic Software Enterprises Ltd (NASDAQ: MGIC)
Q1 2019 Earnings Call
May 16, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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 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.

Amit Birk -- Vice President, M&A and General Counsel

Thank you, and good day everyone. Our quarterly earnings release was issued before the market open 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, the reconciliation schedule showing GAAP versus non-GAAP results has been provided in the press release issued before the market open 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.

Guy Bernstein -- Chief Executive Officer

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 our revenues, operating income and net income, which demonstrated 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's SmartUX, a leading low-code development platform for mobilizing and modernizing enterprise apps, which is strongly synergistic to the technology and paradigm of Magic 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 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.

Asaf Berenstin -- Chief Financial Officer

Thank you Guy, and good morning everyone. Our first quarter revenue 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 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 revenues. Most of our growth in the first quarter in 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 all Professional Services, as Professional Services accounted for 85% of 2018 growth.

The breakdown of 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 (ph) .

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 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%, upto 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 profits.

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 had cash and cash equivalents, short and long-term bank deposits and marketable securities of approximately $109 million (ph) compared to approximately $160 million (ph) 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 aggregate amount of approximately $7.3 million for the second half of 2018, which reflects the dividend yield of approximately 3.1% and the remaining decline for resulting from M&A.

Total financial debt as of December 31, 2018 amounted to approximately $28 million same as at the end of -- 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 the new accounting standards ASC 842, which required 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 $319 million (ph) 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. Guy?

Guy Bernstein -- Chief Executive Officer

Thank you, Asaf. In summary, we are pleased to witness that the strong momentum for 2018 continued to 2019. We continued 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 requirements of organizations to complete their transformation through digital workplace.

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

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. (Operator Instructions) The first question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays Capital -- Analyst

Hi, good afternoon. Thanks for taking my questions. 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 (ph) 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? Thank you.

Guy Bernstein -- Chief Executive Officer

Okay, fine. Well, I'll talk a little bit about the synergy and how we see it, and maybe then the numbers, Asaf can add somethings. But as far as synergy, we are looking synergy in two levels. First -- or the two of them, so first and second. But technology wise and paradigm and methodology and go-to-market and 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 an organization, methodology, sales people, communicating the added value, et cetera is already there by definition.

Technology synergy -- Magic in the last two years, we've developed our Web Client, an Angular solution, which transform 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 putting 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 two products are actually sync technology wise as well, of course, we will have to invest some effort in the next 12 months to build the technology because it's two different technology stacks, but there (inaudible) have a lot of good symbiosing (ph) relationship between them.

And we are going to take the PowWow platform and do localization and bring it into our existing branches 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 the Japanese company in order to sell in Japan. So, synergy is strong in all aspects, OK. We want to talk about price effectiveness on the incomes.

Asaf Berenstin -- Chief Financial Officer

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

We are still analyzing the investment or the business plan that we want to come up with, or the pricing model that we think would best fit to address this platform as the code more than that we are applying is a subscription mode. This is why the beginning revenues are considered low, and then, as you prolong the service it's kind of builds-up one over the other, and then you get significant stack of inflow coming in.

Tavy Rosner -- Barclays Capital -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

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. 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 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 had 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 on the second quarter we already see the improvement, especially on our Professional Services side, and also on the sale of the software.

Tavy Rosner -- Barclays Capital -- Analyst

Okay. Thanks. I appreciate it. Thanks Guy.

Operator

The next question is from Maggie Nolan, William Blair. Please go ahead.

Maggie Nolan -- William Blair & Company -- Analyst

Hi. 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 kick-off, obviously that puts some pressure on the gross margin this quarter, maybe it will pressure gross margin in future quarters. But your operating margins did hold up pretty well. So, as we see that mix trend upward a little bit, what are some of the levers that you can pull to keep a more stable operating margin profile?

Asaf Berenstin -- Chief Financial Officer

I think that, first of all, I want to say that Q1 gross profit is not something that represent our core and 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, where at Saint Petersburg location. I can tell you that two years ago, we had approximately 40 people in Saint Petersburg location. Now we have close to 200 people that provide offshore services to customers mainly in the US.

And with that, this is how we think that we can maintain -- delivered a 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.

Maggie Nolan -- William Blair & Company -- Analyst

Okay, understood. And then, when we're thinking about the guidance range and 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?

Guy Bernstein -- Chief Executive Officer

Hard work and luck.

Maggie Nolan -- William Blair & Company -- Analyst

Are particular build up in the pipeline things here, you're hoping to convert, you know, is that looking strong, and kind of playing into that high-end of the guidance? Or is there any color you can give there?

Guy Bernstein -- Chief Executive Officer

You know 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 the 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 you start to move, but you know at the end you are dependent on big giant that some time it take them a bit more time. Although they give you the 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.

Maggie Nolan -- William Blair & Company -- Analyst

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

Guy Bernstein -- Chief Executive Officer

In terms of what?

Maggie Nolan -- William Blair & Company -- Analyst

Bottom line is they're going to be dilutive to EPS, just given some of the investments?

Guy Bernstein -- Chief Executive Officer

Probably 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 provisions. 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 uncommon (ph) .

Asaf Berenstin -- Chief Financial Officer

Things are 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 -- why these companies are 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 $0.04 per share negative impact.

Maggie Nolan -- William Blair & Company -- Analyst

Okay. Thanks. That was very helpful. Thanks guys.

Operator

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

Guy Bernstein -- Chief Executive Officer

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.

Operator

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.

Duration: 21 minutes

Call participants:

Amit Birk -- Vice President, M&A and General Counsel

Guy Bernstein -- Chief Executive Officer

Asaf Berenstin -- Chief Financial Officer

Tavy Rosner -- Barclays Capital -- Analyst

Maggie Nolan -- William Blair & Company -- Analyst

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