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Magic Software Enterprises Ltd (MGIC) Q2 2019 Earnings Call Transcript

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Magic Software Enterprises Ltd (NASDAQ: MGIC)
Q2 2019 Earnings Call
Aug 13, 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 Magic Software Enterprises 2019 Second Quarter Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

With us online today our Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's VP of Technology & Innovation, Mr. Yuval Lavil; and Magic's VP, M&A and General Counsel, Mr. Amit Birk.

I'll now 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 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 obligations to update or revise any of these forward-looking statements, whether because of future events, new information, a change in its view or expectations or otherwise. Also, during the course of today's call, we will refer to non-GAAP financial measures. The reconciliation schedules showing a 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 -- on the Company's website.

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

Asaf Berenstin -- Chief Financial Officer

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 this 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 and our National Election Day. We are proud to conclude our quarterly and half year results with continued growth across all our major financial indices[Phonetic]. 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 continued to experience in this quarter a certain decline in our business activity with CVS. Such decline was compensated with new project 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 for M&A based on our current deal backlog as we are on final stages to acquire US-based software service company.

Looking at the geographical breakdown of our revenues. During the second quarter, North America accounted for 48% of our total revenues, Israel 36%, Europe 9% and APAC and the rest of the world accounted for 7% of our annual revenues. Most of our growth in 2019 is in absolute numbers was traditionally from 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. 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 solutions 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 solutions and 48% related to our professional services, compared to 54% related to software solutions and 46% related to professional services in the respective period. Our solid performance continued to be driven by the increasing demand for diverse portfolio of innovative software solutions and professional services, evidenced by a ever expanding base of new customers and strategic partnership with major organization and ecosystems.

Moving to operational cost. 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 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 into development efforts to India and open 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[Phonetic] and in the first quarter of 2019. Our operating income for the second quarter included a first time consolidation of PowWow, our recent acquisition and the creator of SmartUX, rapid low-code development platform, which was completed on April 1st. As we indicated on the announcement of the deal, PowWow is not expected to be accretive to our results during the first 12 months to 18 months following additional investment 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 cents per fully diluted share, compared to $7 million or $0.16 of fully diluted in the same period last year. Earnings per share for the second quarter of 2019 were negatively impacted by an amount of $1.04 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 $160 million at the end of 2018. Our total financial depth 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 Enterprise Board of Directors have declared a semi-annual cash dividend in the amount of $0.156 per share and 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 strong financial results demonstrate that Magic is continuing its impressive forward momentum with growth in both revenues and profits. A record breaking first half results for 2019 confirmed that our strategic business initiative are paying off. On the M&A front, we continue with our effort to find potential companies that fit our strategy and our evaluation range.

We are currently looking for small-to-mid sized companies with revenues in the range of $20 million to $50 million, which we follow our strategy, geographic expansion, complementary products and customer base.

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 Maggie Nolan of William Blair. Please go ahead.

Ted -- William Blair -- Analyst

Hi, this is Ted on for Maggie. Thanks for taking our questions. 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?

Asaf Berenstin -- Chief Financial Officer

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

Guy Bernstein -- Chief Executive Officer

Legacy transformation.

Asaf Berenstin -- Chief Financial Officer

Exactly, in today's legacy transformation in enterprises. Our results did include one transaction that we worked for term license with a significant financial institution in the US for three years now for approximately total deal value of $800,000. For us, it's another evidence of the benefit that the companies can -- and enterprises can generate from such a platform.

Ted -- William Blair -- Analyst

Understood. And so 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 2019?

Asaf Berenstin -- Chief Financial Officer

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

Ted -- William Blair -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

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

Ted -- William Blair -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

Basically, for this quarter, CVS accounted for around 13% -- close to 15% of our revenues, but fairly to day 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 up and we are again receiving new projects and getting new people -- additional work force in CVS. So currently, I don't expect this decline to continue. But on the current run rate versus 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 US and also Israel with existing customers. We signed a new project in Azerbaijan for cyber and command and control center, so -- with a much higher gross profit then the ones that we lost with CVS. So all-in-all this is why, though we are losing like $10 million in terms of annual revenues from CVS, we still manage to maintain a profitability and even improve our gross profit.

Ted -- William Blair -- Analyst

Great. That's a very helpful color. I 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?

Asaf Berenstin -- Chief Financial Officer

Yes.

Ted -- William Blair -- Analyst

Alright. And then last question from me, and I can hop back into line. So over the last year or so, the adjusted operating margins hit 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? Thank you.

Asaf Berenstin -- Chief Financial Officer

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

Ted -- William Blair -- Analyst

Those 14% to 15%.

Asaf Berenstin -- Chief Financial Officer

Yes.

Ted -- William Blair -- Analyst

Alright. Very good. Thank you.

Operator

The next question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays -- Analyst

Thanks for taking my questions. You guys mentioned your thoughts 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.

Asaf Berenstin -- Chief Financial Officer

We have today approximately 120 employees in India. We aim to increase that amount to up to 150. Again, when I'm saying increase that amount, its 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 St. Petersburg, we have around 150 employees today. Most of them are in the field of delivery, doing projects mainly to customers in the US today. And around -- I would say, out of them, around 40 are engaged in R&D activities.

Tavy Rosner -- Barclays -- Analyst

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

Guy Bernstein -- Chief Executive Officer

Probably, it will improve margins. But, we were talking about small numbers.

Tavy Rosner -- Barclays -- Analyst

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

Guy Bernstein -- Chief Executive Officer

This market is huge, but as any of our technology market, it's segregated into different segment and businesses, like if you say, IoT, how big is the market of IoT? So there is basically no limits. Okay. But we are focusing on a sub-segment 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.

Tavy Rosner -- Barclays -- Analyst

Thanks, guys. I appreciate it.

Operator

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

Kevin Dede -- H.C. Wainwright. -- Analyst

Thanks. Afternoon, Gentlemen. Asaf, you mentioned that $800,000 three-year deal financial institution in US, is that the excess of PowWows[Phonetic] one that you announced during the quarter?

Asaf Berenstin -- Chief Financial Officer

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

Kevin Dede -- H.C. Wainwright. -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

No.

Kevin Dede -- H.C. Wainwright. -- Analyst

Okay. Alright. So -- you talked a little bit about FactoryEye, are there solutions there that are available from some of the larger software vendors, anything that is specific to what mid-tier manufacturer might need?

Asaf Berenstin -- Chief Financial Officer

Again, there are the ones that you know target manufacturing like Daimler or companies like that, which is really going to end-to-end improving performance and efficiency in a factory. Okay. So we're not trying or we're not aiming to compete with those when coming to project, which are in, like $50,000 and above with the peers and stuff like that, not to the $1 million -- $2 million or $3 million project. Okay. So we're kind of trying to put ourselves in a separate focus of the market.

Kevin Dede -- H.C. Wainwright. -- Analyst

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?

Guy Bernstein -- Chief Executive Officer

No, what we basically did, we went internal and did our SWOT analysis internally, and we found out that we have quite a lot of customers in the manufacturing arena already that are using our technology -- in the North America under Oracle JD Edwards' technology that we have, a good partnership there. So we found out that we are already -- in this domain, already. And then we saw the needle. Again, analytics and some kind of machine learning and a little bit of the IOT that all of us are in the technology arena are looking at. And we think that we came up with the niche that actually covered this quite well. Okay. So that was the incentive and this is the feedback 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, in the first six months of this launch of this full suite of a solution. But the interest is quite strong all around us.

Kevin Dede -- H.C. Wainwright. -- Analyst

So in the US, 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 with specifics to Europe and maybe South America and other geographies?

Asaf Berenstin -- Chief Financial Officer

I think 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 a significant transaction with another financial institution last year that was announced for five years 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 said that we are still need to invest in expanding our sales capability, our marketing capabilities and the localization of the SmartUX also to the Japanese market.

Kevin Dede -- H.C. Wainwright. -- Analyst

Okay. Thanks, Asaf. 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, and maybe they would ask you to help them on certain projects.

Asaf Berenstin -- Chief Financial Officer

This is a 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 they will decide how to go with, I'm sure that we will hopefully also benefit from that decision. This is still by 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.

Kevin Dede -- H.C. Wainwright. -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

It's the same. Yeah, it's the same 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 still manage -- and the fact that we managed to compensate that, we still manage to meet that guidance.

Kevin Dede -- H.C. Wainwright. -- Analyst

Okay. Alright. The -- I know you mentioned a few days, so the quarter was shorter. Was it just three 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?

Asaf Berenstin -- Chief Financial Officer

It was 6% lower than the previous quarter.

Kevin Dede -- H.C. Wainwright. -- Analyst

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?

Guy Bernstein -- Chief Executive Officer

Yes, we are pretty close to [Indecipherable]

Kevin Dede -- H.C. Wainwright. -- Analyst

Okay. Will that get a separate press announcement once that happens is [Speech Overlap] or.

Guy Bernstein -- Chief Executive Officer

Yes.

Kevin Dede -- H.C. Wainwright. -- Analyst

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

Guy Bernstein -- Chief Executive Officer

No, we expect it will happen this quarter.

Kevin Dede -- H.C. Wainwright. -- Analyst

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

Guy Bernstein -- Chief Executive Officer

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 some.

Kevin Dede -- H.C. Wainwright. -- Analyst

Now 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?

Guy Bernstein -- Chief Executive Officer

I say, all of the 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 private equity funds, it's very hard for us to compete with them.

Asaf Berenstin -- Chief Financial Officer

Like when you are going to a company and doing any certain amount of profits, and they are saying, OK, we are doing this amount, and we look at Magic and they don't even take into consideration, let's say, the cash that they have -- in my balance sheet. Let say, your valuation in comparison to your EBITDA is around multiple of term. So we expect the multiple of them. Now there are like a very small business with many -- sometimes have a significant customers factor being. And their expectation are still to the roof.

Kevin Dede -- H.C. Wainwright. -- Analyst

I understand. Alright. 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 are generating so much cash?

Asaf Berenstin -- Chief Financial Officer

Again, as guidance says we are continuing to look for companies. As we indicated, we are going to close the deal in 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 lag in the process of negotiating. So I think, that this company knows how to do transaction with this 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 companies to...

Kevin Dede -- H.C. Wainwright. -- Analyst

[Speech Overlap] yeah, 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..

Guy Bernstein -- Chief Executive Officer

No, the with regard to the debt -- I'm talking about relating to the debt the interest is very low. So, we can close it if you want. We don't see the niche.

Kevin Dede -- H.C. Wainwright. -- Analyst

Okay. Fair enough. Alright. Well, thanks very much, gentlemen. I appreciate you taken all my questions.

Asaf Berenstin -- Chief Financial Officer

Thanks.

Operator

[Operator 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 for joining our call. And we hope to bring you some good news in the very near future. Thank you.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

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

Asaf Berenstin -- Chief Financial Officer

Guy Bernstein -- Chief Executive Officer

Ted -- William Blair -- Analyst

Tavy Rosner -- Barclays -- Analyst

Kevin Dede -- H.C. Wainwright. -- Analyst

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