Guy Bernstein - CEO Asaf Berenstin - CFO

Tavy Rosner - Barclays Debra Fiakas - Crystal Equity Research Alper Tuken - William Blair Kevin Dede - H. C. Wainwright

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Limited First Quarter 2015 Results Conference Call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. [Operator Instructions]. I'd also like to remind you that this call is being recorded. With us on the line today are Mr. Guy Bernstein, CEO; and Mr. Asaf Berenstin, CFO. Before we start, I'd 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. The company expressly disclaims any obligation to update or revise any of these forward-looking statements whether because of future events, new information, change in its view or expectations or otherwise. On this call today, management will provide you with details of our Magic's performance in the first quarter of 2015, including certain non-GAAP financial measure. The company provides non-GAAP financial measures because they believe that they are the most valuable ways to review its core operating results. The company provided a reconciliation of non-GAAP measures to the comparable GAAP measures in its earnings release, which was issued before the market opened this morning, and has been posted on the company's website at www.magicsoftware.com. A replay of this call will be available after the call on the Investor Relations section of the company's website. I would now like to turn the conference over to Mr. Guy Bernstein of Magic Software. Guy, please go ahead.

Good morning everyone and thank you for joining us today as we report our first quarter 2015 financial results. I will provide a highlight of our first quarter results, and then turn it over to Asaf, who will dive into the numbers. I will be happy to address any of your questions at the end. We are pleased with our first quarter results, including operating margin. Revenues in the first quarter reached $40.3 million with non-GAAP operating income of $6.7 million. Had it not been for the negative impact of foreign exchange rates this quarter we would have reported record breaking revenue of $42.8 million and record breaking non-GAAP operating income of $7.3 million, reflecting an increase of 14% year-over-year. We continued to enhance our products and enable our customer to benefit from the latest technology including in-memory computing, HTML5 and mobile. We were to strengthen our relationship with strategic partner including Oracle, SugarCRM, and Salesforce.com, and enhance some wins as a result. We continue to advance our existing M&A opportunities, as well as being on the lookout for new one. I would now like to turn the call over to Asaf Berenstin, our CFO, to discuss the financial results in more detail. Asaf, please?

Thank you, Guy. Today we will be analyzing our results on a non-GAAP basis, which as mentioned at the beginning of the call, better conveys the operational state of our business. The financial tables provided in our first quarter 2015 earnings press release included detailed reconciliation of non-GAAP measures to the comparable GAAP measures. As Guy mentioned, our first quarter revenue was $40.3 million, compared to $40.9 million for the fourth quarter last year, and compared to $42.5 million for the first quarter of 2014. In our previous call, we discussed the negative impact of foreign currency exchange raises to the U.S. dollar on our top and bottom-line as we derive approximately half of our revenues from EMEA and APAC. Unfortunately, foreign currency eroded certainly in the first quarter and negatively impacting our revenue by approximately $2.5 million to $3 million compared to the first quarter of 2013, and by approximately $1 million compared to the fourth quarter of 2014, mainly due the devaluation of the Euro, Japanese Yen, and new Israeli Shekel, which decreased 18%, 16%, and 13% respectively against the U.S. dollar compared to the first quarter of 2014, and 10%, 4%, and 3% respectively compared to the fourth quarter of 2014. If we eliminate the legacy impact of the erosion of foreign exchange rate compared to the first quarter of 2014, revenues for the third quarter would have reached a record-breaking result of $42.9 million reflecting an increase of 5% year-over-year. These quarter results don't include revenue for our latest acquisition, which was announced in February and closed in April. We look forward to show its impact next quarter. Our non-GAAP operating income for the first quarter of 2015 was $6.7 million with 16.6% operating margin, up 5% compared to non-GAAP operating income of $6.4 million with 15.6% operating margin in the first quarter last year. If we eliminate the legacy impact of foreign exchange rate erosion compared to the first quarter of 2014, non-GAAP operating income for the first quarter would have reached a record-breaking result of $7.3 million, reflecting an increase of 14% year-over-year, with non-GAAP operating margin of 17%. Financial expenses this quarter totaled approximately $900,000 compared to financial expense of $140,000 in Q1 2014. The financial expenses are solely attributed to the impact of devaluation of monetary assets resulting from currency erosion. Our non-GAAP net income was $5.2 million or $0.12 per diluted share based on 44.5 million fully diluted shares outstanding, compared to the non-GAAP net income of $5 million or $0.12 per diluted share, based on 39.9 million fully diluted shares outstanding in the first quarter last year. It we eliminate the negative impact of the erosion of foreign exchange rate compared to the first quarter of 2014, non-GAAP net income for the first quarter would have reached a record breaking result of $6.7 million, reflecting an increase of 34% year-over-year or $0.15 per diluted share. Turning to the balance sheet. We ended the quarter with $88.5 million in total cash and short-term investments. From a cash flow perspective, we generated $9 million from operating activity in the first quarter in 2015, a significant improvement from the $4.5 million in the first quarter of last year. Our strong financial position including strong free cash flow, enable us to maintain a dividend policy for our shareholders. Our policy is to return up to 50% of our net income in the form of dividend. During the first quarter, we distributed on aggregate approximately $3.6 million or $0.081 per share in accordance with our dividend policy with respect to our 2014 second half results of operation. Our current dividend yield is approximately 3%. With that, I will turn the call back to Guy.

Thank you, Asaf. In summary, we had another solid quarter. However our results could have even better had we not been hit by the devaluation of foreign currencies. We are confident in our growth strategy, remaining focused on profitable growth and enhancing our position with strategic acquisitions. Today we announced that we expect full-year 2015 revenue of approximately $156 million to $173 million. When measured based on 2014 foreign currency exchange rates, this guidance represents full-year 2015 revenues of approximately $175 million to $182 million, reflecting managing growth expectation of between 7% to 11%. With that, I will now turn the call over to operator for questions.

Thank you. [Operator Instructions]. The first question is from Tavy Rosner of Barclays. Please go ahead.

First question perhaps for Asaf, when you look at this quarter's results you mentioned good underlying results in margin. So I was wondering if you could give us some color on what driver for the operating margins is it the mix of revenues or decrease in costs, any color would be helpful?

Yes. As usually the changing operating margin and our gross margin is dependent on the mix of our revenues. Basically, if you compare our results to the previous quarter, to Q4, then we saw improvements in especially the level of sales of our software products. The only thing that of course also impacts our gross margin operating profit is the impact that we get from the erosion of currencies, which mostly are being affected from the Euro, Japanese Yen, new Israeli Shekel, may be as when we have significant amount of sales of the licensed product on software product. So this is something that of course impacts our gross margin.

When we look at your guidance, I believe, the underlying is 7% to 11% growth excluding for the FX in that slightly below the color that you gave last quarter I think we were more in the 12%. Has anything changed in your end markets that you're serving?

I think the main reason for that we -- I mentioned before that we had a lot of business with the telecommunication sector and we all thought that after the big merger between AT&T and DirecTV things will catch-up. And apparently not that they didn't it became even more slow. So we are still waiting as we would rather be conservative rather than come up with higher numbers. So I think for now we feel more comfortable before we touch numbers until we will see where the factor is going to.

Okay. Understood, thank you. I'll go back to the queue.

The next question is from Debra Fiakas of Crystal Equity Research. Please go ahead.

I also want to continue the general line of discussion about the anticipated business. You anticipate any changes in your mix of business geographically that would also have an impact on the mix of currencies in your revenue?

I cannot say that we anticipate something dramatic. Right now, 50% of the business is coming from the States. The problem is that the remaining 50% is coming from other places. And as you know currencies went down dramatically and we suffered from there. For the short-term, I don't think it will change in terms of the mix. Hopefully, currencies it will evaluate a bit.

Okay. Thank you. And the fact that the AT&T and DIRECTV deal didn't go through, that’s not going to reduce your presence in the U.S. market?

No. I think what you see the low run rate, right now.

Okay. Okay, very good.

We expected it to pick up before because when we had all the signs at the beginning, let's say, at mid last year we had all the signs that things will pick up, and unfortunately they didn't. So what you see is the kind of the bottom hopefully.

All right. Very good. And then just help out a bit with the modeling. Could you maybe give us a little bit of description in the mix of business, software versus maintenance and technical support or consulting services?

Basically, these doesn't change over their original change over the last eight quarters, [indiscernible] 70% of our revenues are coming from software services, professional services that we provide 30% are coming from sales of software products maintenance and support. This is something that is pretty much stable over the last three quarter.

Okay. And then just another sort of housekeeping question. It sounded like you had a very great quarter in terms of generating operating cash, and I wondered if perhaps you could characterize the sources of the operating cash beyond the net income. Was it mostly working capital contributions or is there something else in that operating cash flow number that is of interest?

I think in the operating cash flow what you see usually during the first half we collapse the maintenance funds.

I see.

So usually in terms of cash flow, the first half is better when you compare it to the net income that we generate.

Okay. Very good. Thank you and I'll go back into the queue.

Our next question is from Bhavan Suri of William Blair. Please go ahead.

Hi, guys. This is actually Alper Tuken in for Bhavan. I just have two quick questions. I know in the press release you mentioned the strong license sales across all the regions. I was just wondering how this compared to kind of the first quarter last year, just in general about the license activity that you guys saw?

If you exclude, one, specific area in Japan where last year we had a tremendous good start for the year because there was some changes in tax legislation and also there was an end of life for a certain Microsoft version that brought forward, transaction that would have come normally during the year. Then we saw improvement in Europe and in the U.S. and all over the other areas that we operate in.

Okay, that's great. And I know you talked about a little bit of slowdown with AT&T and DIRECTV, but may be just wanted to get your thoughts on what the pipeline for that could potentially look like in the back half of this year, if you can maybe see an acceleration of activity there?

They're talking all the time about acceleration. The problem is that they talk to bought it like six months ago when we were quite confident that it will come and it didn't. So they still talking about the acceleration, they’re talking about many projects that they should launch. But for now, we are still running on the, let's say their minimum of what we saw from them in the last probably three, four years. So it’s not going down, which is a good news, but it’s not picking up yet as we expected.

Okay. And then just one last real quick one. I noticed that selling, marketing, and general and administrative expenses as a percentage of revenue are the lowest they’ve ever been, was this mainly due to currency or is this kind of a structural change in how you guys were looking at those expenses?

I would say mostly currencies but we did make some changes in the structure of the business.

Okay. Okay. Thank you. That's all for me. Thank you guys.

What you can see is that no matter if the -- what impact you see on the revenue, usually we are kind of ahead in terms of the expenses and we do what’s needed in order to keep good margins.

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

Could you give us a little insight on the -- I think I know you’ve mentioned decent pipeline on the acquisition side. Can you give us a little more color on the one that you've done and the pipeline. You said that this one closed in April. Could you give us any sort of framework on how you expect to contribute and how you expect to take the services of that company delivers to other geographies, and then detail on the pipeline?

Okay, in relation to the acquisition we just closed, we are taking about high level professionals that are dealing mainly with mainframes. As you know, we have the AppBuilder platform that we market. And this company is heavily based on the Israeli market. What we intend to do is basically to take it to our abroad customers, because, as you know, AppBuilder reselling almost everything outside of Israel. So we intend to use them and of course to grow the business we already signed the ninth deal, the problem is that we cannot announce anything because when we work with giants just in order to get the permission to announce anything you need to wait probably few years, but we already see some good sign from this acquisition which is good.

Okay. You mentioned, I apologize I don't know if you got, did you mention the platform, could you just apparently just kept all the [indiscernible] a little bit over here, I was just wondering what platform you were referring to.

To AppBuilder.

I'm sorry?

To AppBuilder.

Okay. All right, so the idea is to extend that?

Yes.

Okay. I'm sorry, go ahead.

Okay. In terms of the pipeline we have currently three opportunities on the table; two we are talking about technology companies. I don’t know to say yet what are the chances in terms of closing. I think with one of them we have agreed on prices but I think the structure is more difficult, shareholders and so. With the other one we have a meeting to discuss pricing. If we agree on the pricing with the second one then of course it can grow faster, because it is a private company, and it is here. And we have the third one, another consulting company in the States that we are checking right now and we'll see about it. Again, I'm trying to be cautious with regard to timing because with the last one we thought we will close it like with the end of last year and because of time constraint we had to wait.

Right, right. So that's outside the NHF issue on that and the Israeli company exorbitant, okay. So can you talk little about approaching environment and valuations? Are you finding it that some of these companies are willing to work with you closely just given scale opportunity or do you still see the M&A environment is pretty hot and a lot of things are closely contested.

I would say that you need to pinpoint the target. The minute they're out there in the market we have difficulties to compete, because you see a lot private equities coming in with enormous amount of money paying huge valuation which usually we don’t pay. So it's a struggle today when you talk about acquisition. Not easy because the minute they have a banker, our chances are going down because of the competition with private equities. Of course if we talk about something, which is strategic toward us then we are willing to pay more and we give a good fight even to the private equity fund. So we'll see about it.

Right, okay. So the mainstream deal that you see that one as being more strategic?

Yes, definitely, it's like one plus one equals two for us.

Okay. Can you give us ballpark on your consultant headcount?

In total?

Yes.

Well, that's a lot. I think today probably we have like 700.

Okay. I was just wondering if you could talk to that level at the end of the quarter, actually post-acquisition versus buyer.

We added -- in this acquisition, we added like 50 to 60 consultants. Again and I think it is important for us to emphasize, our consultants are working only if they generate revenue. The minute we see that they don’t we don’t hold any bench.

Right. Okay. Could you talk a little bit about, I mean I suppose this a little bit better for us. Could you talk a little bit about how you might try to hand some of the currency fluctuations?

It’s a problem because for the long term I think we have kind of natural hedge between the markets. So every now and then, you see that the euro goes up or down and you see it that the Yen suddenly it's picking up. I don’t think we can protect our revenues, definitely not the revenue because it will probably cost us a fortune. We are trying here and there to catch up with peaks in order to protect our bottom line, but yes, if you have, for example you have receivables that are based on local currency very hard to protect it. So, you see some fluctuation. I think in the long terms it prove that the natural hedge is working.

Can you talk little bit about how you see some of the largest software houses, IBM, Salesforce, Oracle, SAP and how you see them working on their development activities to more closely work together? I think the big question on my mind is always, and just so the longer term vision probably that I just see more of those companies working more closely together to provide a higher level of your own integration making it a little bit difficult to some of the smaller consultancies to offer services, and I guess I’m going to ask that question every quarter, so could you just give us an update on your view on that?

Yes, I can relate to two of them. I can relate to Salesforce and SugarCRM. As for Salesforce, we work quite independently with their customers. Every now and then we get some approach from them talking about some partnerships, but till now just discussion, I didn’t see anything coming out of it. With SugarCRM, we started to discuss the real partnership and let see how it develops. It looks like they’re here.

I see. Okay. I’m also; I guess just from a software integration perspective and mostly on how those software platforms integrate with the other large ERP systems, could you just talk a little bit about how you see that developing?

You need to divide it between the type of customers you’re dealing with because if you talk about the big customers that they are using R3 for SAP, usually they will follow SAP with their integration platform no matter how costly it is. When you go to the mid level then pricing becomes important and pricing and functionality, this is where we play. So some of them are going after the cost, some of them are going after the plug and play, the fact that you can make it work faster. Some of them are looking after the vision to feel that you can support their cloud capabilities. It varies between the customers.

So I guess in general, I'm wondering if you've seen a dynamic change at all. Do you see Salesforce, and SAP, Oracle pushing down to some of the smaller companies or do you think it is still too closely tied to pricing and functionality?

I think all of them are trying to push down. I think the price will vary for them.

Okay. Can you talk a little bit about the development that you guys are doing in-house? And then what was the big push where we have not seen that many middle announcements. I'm wondering where you have your R&D team focused and what you think the most exciting developments that you might have to come out we should be looking for.

I still think that the mobile part is the most exciting part. The reason you don’t see announcement is because most of the deals are rather small. So we don’t see any point in announcing on that. But there is definitely that most of the interest is on mobile.

Okay. So from a software development perspective, is that still your primary focus?

Definitely.

Okay. Can you talk a little bit about some of the things that you're working on and how you are putting your R&D dollars to work and how you thinking you might be able to differentiate your platform from some of the other companies, there's definitely a lot to focus on mobile?

I think in general we are concentrating on the two mainstream platforms probably 200. The idea is to allow developers to develop with the Magic platform in a totally agnostic way to the deployment so we can choose how to deploy it later on. I think we keep on the same methodologies we had in the original standard world of development. We stick to it with mobile as well.

And can you just talk about your access to R&D talent? Are you trying to add more people to build the ranks there and, if so, where you are trying to build your R&D effort?

I think here and there on a minimal scale, we do hire more experts especially when you talk about niche expertise, but all in all the team here is quite experienced and everything is kind of hooked up to the original platform. Therefore, even if I bring like the newest brain talent, he will not be effective unless someone would work with them on the clauses.

Right, right. Okay. How you see your 700 headcount in relation to the 156 and 173 guidance that you offer? Are you thinking that you revealed your headcount guidance with the headcount that you have, do you think you are going to have to deal with the folder in one or may be three of acquisitions that you talked to?

No, currently the acquisitions that we talk about are not included and, yes, we definitely think that we can hit the guidance with everything ha comp it up.

Great. Okay. Well, thank you very much for taking all my questions.

Thank you.

[Operator Instructions]. The next question is from Neil [indiscernible] of Maxim Group. Please go ahead.

Yes, thank you for taking my question. For the guidance of 7% to 11% year-over-year growth on a cost and current basis, could you provide some color as far as how much of a contribution the existing acquisitions that you just made we will make to that, as well as if there is any if there are future protection acquisitions are embedded in that number as well?

The future acquisitions are not included in this number, and the current one is rather small so I tend to [indiscernible] percentage it is like [indiscernible] less than 5%.

Less than 5%. Okay. And did you provide, how much you guys paying for this acquisition here?

No, we didn’t.

Did not, okay.

But it's a good buy.

And then you mentioned that this is a strategic acquisition. Could you explain why it is so strategic, especially give that it is specializing with mainframe environments, from my understanding environment, mainframe environment is something that hasn’t been declined. A – Guy Bernstein: So let’s talk about the mainframe market. I don’t know if you’re aware, but the mainframe market, everybody is talking about the 70s declining. But I must say that every year we’re doing better and better on our mainframe platform. The thing with the mainframe is that when you work in high scalability in many big organization with the only machine that can support such huge transaction, and, therefore, people tend to keep this machine running. And as you know, to find mainframe consultants is larger. Here we took a company with mainframe consultants of the [indiscernible] people. Usually when you talk about mainframe guys, you see people are between 50s to 60. Here, we’re talking about young people. And we know how to hire and train more and more people that are mainframe. And the reason the huge depends on repeats from our customers, usually when they look for people quite hard for them to find people. It's either quite expensive or just how to find the right people, and we definitely hear the opportunity of bringing our customers on fresh guys, mainframe experts is [balancing].

There are no further questions at this time. Mr. Bernstein, would you like to make any concluding statement?

Yes. So thank you all for joining our call again. And we’ll of course be happy to come with good news in the near future. And talk to you soon.

Thank you. This concludes the Magic Software Enterprises Ltd. first quarter 2015 results conference call. Thank you for your participation; you may go ahead and disconnect.