Guy Bernstein - Chief Executive Officer Asaf Berenstin - Chief Financial Officer Amit Birk - Vice President, M&A and General Counsel Itai Galmor - Vice President, Global Marketing and Business Development

Bhavan Suri - William Blair Tavy Rosner - Barclays Kevin Dede - Wainwright

Welcome to the Magic Software Enterprises Ltd. Third Quarter 2015 Results Conference Call. All participants are currently in listen-only mode. Following management’s 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; Mr. Asaf Berenstin, CFO; Mr. Amit Birk, VP, M&A and General Counsel; and Mr. Itai Galmor, VP, Global Marketing and Business Development. I’ll now turn the call over to Mr. Amit Birk of Magic Software. Please begin.

Thank you and good morning to everyone. Our quarterly earnings release was issued before the market opened this morning, and is available 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. The company 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. On this call today, we will provide you with details about Magic’s performance in the third quarter and first nine months of 2015, including certain non-GAAP financial measures. We provide a non-GAAP financial measure because we believe that they are the most valuable way to review our core operating results. We have provided a reconciliation of the non-GAAP measures to the comparable GAAP measures in our earnings release. A replay of this call will be available after the call on the Investor Relations section of the company’s website. I will now turn the call over to Guy.

Good morning, everyone. And thank you for joining us today as we report our financial results for the third quarter and first nine months of 2015. I will review the highlights from our third quarter, and then turn it over to Asaf who will provide more detailed financial information. I will be happy to address any of your questions at the end. We are pleased with our third quarter performance including record breaking revenues of $45.3 million reflecting 13% year-over-year growth and double digit growth in non-GAAP net income. Non-GAAP net income was $5.7 million, a year-over-year increase of 14% and our earnings per share of $0.13 was an increase of 18% year-over-year. We are continuing to see a solid demand for our software and professional services from all regions demonstrating the relevance of our enterprise mobility, cloud integration and Big Data solutions as companies move forward with digital transformations. Our focus on operational discipline while enriching our offerings and enlarging our customer base has enabled us to maintain non-GAAP operating margins of over 15% despite foreign currency devaluations and a changing revenue mix. We are confident with our projections and are maintaining our revenue guidance of $166 million to $173 million for the full year 2015, reflecting 7% to 11% growth rate on a constant currency basis. I’d now like to turn the call over to Asaf Berenstin, our Chief Financial Officer, to discuss the financial results in more detail. Asaf, please go-ahead.

Thank you, Guy. Good morning, everyone and happy Veterans Day to our American listeners. Today, we’ll be analyzing our results on a non-GAAP and constant currency basis, which as mentioned at the beginning of the call provide valuable supplemental information regarding our results of operation consistent with how we evaluate our performance. As Guy mentioned, we produced record breaking third quarter revenues growing 13% to $45.3 million compared to $40.2 million for the third quarter last year and compared to $42.5 million in the second quarter of 2015. While we are pleased with these record breaking numbers, has it not been for the negative impact of the erosion of foreign exchange rates, we would have strong quarterly revenues of $47.8 million reflecting a 19% increase year-over-year. The foreign currency erosion in the third quarter negatively impacted our revenues by approximately $2.5 million compared to the third quarter of 2014, mainly due to the devaluation of the New Israeli shekel, the Euro and Japanese yen which decreased 9%, 16% and 15% respectively compared to the third quarter of 2014. Turning now to profitability, our non-GAAP gross profit for the third quarter of 2015 was $16.7 million, up 3% compared to non-GAAP gross profit of $16.3 million in the third quarter last year. Non-GAAP gross margin was 36.8%, down from 40.4% for the third quarter of last year. On a constant currency basis, non-GAAP gross margin for the third quarter would have reached 7.9%. The fact that over 50% of our software license and maintenance and support revenue which carry gross margins of over 85% generated in currency other than the U.S. dollar means that the currency erosion negatively influenced gross margin by 1% and our gross profit by $1.4 million compared to the third quarter last year. Non-GAAP operating income for the third quarter of 2015 was $6.6 million, up 3% compared to non-GAAP operating income of $6.4 million in the third quarter last year. Non-GAAP operating margin decreased to 14.6% compared to 16% in the same period last year. On a constant currency basis, non-GAAP operating income for the third quarter would have reached $7.1 million, reflecting an increase of 10% year-over-year with non-GAAP operating margin of 14.8%. Financial income this quarter totaled approximately $389,000 compared to financial expenses of $486,000 in the third quarter of 2014. Our non-GAAP net income was $5.7 million or $0.13 per diluted share based on 44.5 million fully diluted shares outstanding compared to non-GAAP net income of $5 million or $0.11 per diluted share based on 45.5 million diluted shares outstanding in the third quarter last year. On a constant currency basis, non-GAAP net income for the third quarter would have reached $6.2 million or $0.14 per diluted share reflecting an increase of 23% year-over-year. Turning to the balance sheet, we ended the quarter with approximately $81 million in total cash and short-term investments generating approximately $15 million from operating activities during the first nine months, a significant improvement from the $8.8 million in the same period last year. Our strong financial position including strong free cash flow enabled 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 a dividend. During this quarter, we distributed a dividend for the first half of 2015 of approximately $4.2 million or $0.095 per share in accordance with our dividend policy. From the beginning of the year, we have distributed approximately $7.8 million or $0.176 per share. Our current dividend yield is approximately 3.2%. With that, I’ll turn the call back to Guy for closing comments.

Thank you, Asaf. In summary, we are pleased with our record breaking revenues and double digit profitability. Revenue for the first nine months stand at $128 million and with our fourth quarter historically being our best quarter, we’re on track to meet our guidance of $166 million to $173 million reflecting a 7% to 11% growth rate on a constant currency basis. With that, I will now turn the call over to the operator for questions.

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] The first question is from Bhavan Suri of William Blair. Please go ahead.

Hey, guys. Nice job and good to see the solid growth in the top line. I guess guys just starting at the top maybe a little color what drove the beat of a top line, was it product, was it services and was it mobility product or the data integration product, how should we think about what drove that upside?

I think first of all the - because the mix has changed this quarter you can see that, I think fortunately it has come from the services. I think normally the migration over to mobility and the new reward you see a lot of integration around this, and therefore it’s kind of going without saying that you have a lot of services around it because in most of the project end user do not know how to move forward. So we need to provide them the [indiscernible].

Got it, got it and then when you think about, sort of, well this one is for Asaf, when you think about the bids and then maintaining guidance is that just conservative on your part or is there something specific a project that ended or something that might end in Q4 that sort of gives you some pause and sort of you didn’t raise full-year guidance because of that?

No, I think that the limelight of the company is pretty clear and then sustainable. So, I don’t this there is anything that might end or actually come up as a big surprise to us, the backlog during this period for the maintenance of course has closed most of the professional services projects are already into the next year, so I don’t think there is any issue with that.

I think we would have -

Go ahead, Guy yeah.

I think the thing is that if you look at this quarter and on a straight line basis you end up Q4, then we shouldn’t be at the top part of your range, but we keep the range because we thought that was the part before especially from the current exchange program, we have been cautious.

Great. And then two quick ones from me just on the business, obviously Microsoft pushing people to Azure pretty heavily, has that changed the competitive dynamics against Microsoft at all and then two, as you look at next year and you look at sort of the growth rate the services business and the backlog, just some color on pipeline on what that might look like given sort of, what sort of comfort does that give you for next year, those two things would be very helpful.

With regard to Microsoft yeah they’re pushing quite hardly Azure. Actually I think we, I might say we even enjoyed because we don’t speak with them directly, so we do tend to get a lot of project that are related, but I still think I’m not such a significant stranger in this market because if you compare them to ours and the rest of them than Microsoft is a big, although we cannot ignore them and they would be significant there. With relation to the backlog or let’s say the business that we see for the next year, or as you know in our business usually when we start the year, 80% of the business is like, I would not say booked but quite secure. So from the 80% you need to bring additional 20% and it is always, when you start the year it looks achievable, we found that range is probably we do it, with [indiscernible] we need to take care and yeah it’s a solid business.

Great, great. And then just a quick update on AT&T, have you seen any of the project work come back there at all?

Not really. We saw some lately in the last two quarters when we saw some new hiring from them, but it seemed significant. I cannot say that it’s a trend. On the other hand, we extended a lot with [indiscernible].

Got it. That’s it from me guys, nice job and thanks for taking my questions and congrats.

Thank you.

The next question from Tavy Rosner of Barclays, please go ahead.

Hello, hey hi Guy, Asaf, Amit, just housekeeping to start with, you gave some good color on the top line growth, if I remember correctly 13% or 19% in constant currency, can you give me some color of what was the organic part of it?

It was 50, 50.

50, 50. That’s also in …

If you remember we bought some consulting company.

Right. So about 9% organic, 9% acquired on the constant currency.

Yes.

Okay. That’s helpful and just wondering also on the margin side so you mentioned 14.8 would have been the underlying number, what would be the right way to think about it as you enter 2016. I know you don’t provide guidance, but do you think that you can squeeze some savings and push the number back above the 15 level?

I can tell you one thing is that I’m not that happy with the 15%, I think we should be better. It is about the mixture of the revenues. In April we will see that this trend continues the service part more significant than we will look for ways to improve the margin.

Yeah that’s helpful and maybe a last one, I was wondering on the demand side when you look at the pipeline, do you come across a customer that would like to take the project that are bit hesitant due to CapEx constraints and therefore you would see them coming more towards 2016?

I’m not sure I understand the question.

Do you see people hesitant to make the investment now and they are kind of sitting on the side, they identified you as being the right provider, but now is not the right time to do the move?

You always see the ones that are quite effective to move forward and you have the ones that are hesitating. As you know, we have the same thing. The ones we decide to push a bit and wait and get more comfort and I think most of them usually you get the year after, some of them decide to not to do anything, so with the case, I don’t see anything different.

That’s helpful, maybe very last one for me on the M&A pipeline, any colors you guys can provide?

Hi, it’s Amit. As Guy said there was a smaller acquisition that we did last quarter. We have few opportunities now that we are checking. I hope that one of them will succeed, but definitely I can tell you that we are checking company now.

Right, thank you guys.

Thank you, Tavy.

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

Amit, I am pretty sure you said that last quarter you had two or three in the pipeline, I’m kind of wondering from the M&A side I’m kind of wondering what changed there and why?

We are very conservative about checking those companies and therefore those two opportunities we decided not to move ahead due to two reasons. One was the value of the company that they look for unreasonable multiples and secondly, the second reason was that it wasn’t good enough for us.

Okay.

I think at the end it is important to understand and when you talk about [indiscernible] target it is like, either you [indiscernible] or not. Meaning you can evolve the whole quarter, check the opportunities, getting to term sheet and then we have, you may become not to do the deal, or the other partner may become not to do the deal. So the fact that we are working on probably three or four every quarter as Amit mentioned, we are quite conservative, we don’t in a rush to spend our manageable theme that would not contribute or in our eyes did not contribute or this is the case.

One more thing just to summarize, these companies that we currently disagree on the multiple sometimes or many let’s say in some of the cases that we have experienced in the past even in most cases those companies came back and we even managed to close the deal, either those companies improved their profitability and then they were able to meet the price that they were after or that they came down and we managed to cut the price in the middle between us. So, the fact that we’re let’s say losing deals on the price it doesn’t necessarily mean that we won’t get it back in the future.

And then to add to that, that in companies that we like and we want to move forward, the gap is the price, in many cases as Asaf mentioned, if you see a situation where we meet them like a year later or it’s more than that and it’s their mix what they pulled off and we keep all the records, then we get more comfort to go for them. And if they don’t, then the product is basically different.

Okay. So to summarize, it’s pretty much based on valuation performance on as you’re working with them through the process. Could you give me an indication on how you suspect valuations have changed over the past year? Do you think people are asking more or how would you look at that?

People definitely ask for more. As you know, in many cases we find those competitors, the private equity funds. Even private equity funds were - they need to show or return on their cash flow and they do not care about their motivation and things that we suffer from they paid off more and we find quite hard to compete with them. And yes, definitely prices went up.

So the two that you - that weren’t able to work out, where they actually bought do you think in private equity because they didn’t meet your metrics?

If they are willing to get [indiscernible].

No, I don’t think so.

Okay, okay. Can you give us a little insight on that little company you did buy? I mean one of the things that you talked about from synergistic perspective was being able to deliver that company’s capabilities internationally and I’m just – given that they were pretty much local in Israel, I’m just kind of curious what kind of progress you made there. Albeit it’s a small contribution, I just wanted to get a feeling for how quickly you were able to bring their solutions to other geographies?

So just in general because there are some legal let’s say notifications, agreements or prohibitus over detailing certain aspect of the deal that at least I’d say in the near future. Basically the company that we acquired is a company that is complementary to services that we already provide to our current activity. So what they do is that being [indiscernible] mainly our service offering. The last carry was a company that is mainly specializing in the telecom industry where we are active and where we want to compensate what we currently are using in business from AT&T. So in that aspect, it was to complement other services mainly our service offering.

Okay.

Also we are looking at the company, we identify the company we’d say that provide higher level of services that can still bring us with more different gross margins and low value services. So we are talking about 25% to 30% or even over 30% in gross margin on those kind of things.

Okay. I’m sorry, I didn’t make myself clear. So I was curious about the company that you did close on. I think it was during the June quarter and my understanding was that they had a specific service and managing mainframe computers and that was the capability that you were hoping to bring to other geographies. And I am just wondering if that type of solution has found customers in other geographies outside Israel.

Currently, we didn’t do anything outside of Israel but we did find credit agreement with one of the giant in the market which we found them that without us it probably wouldn’t happen.

Okay, good. Congratulations on that. Now, on that some of the discussion around the gross margin, would you mind growing over that again, I didn’t understand why it fell sequentially.

Because again most of the, for example, we will take the impact on revenues that we had this quarter of $2.5 million then almost let’s say close to half of this amount refer to devaluation over maintenance in software licenses that we sell. So for that amount that we lose, there are almost not – there isn’t any cost of goods sold against that amount. So you get that directly into the volume of your gross margin. So this still takes us at least 1% of our gross margin, that’s the main impact. On professional services, even though the other half referred to professional services because there the gross margin is much smaller, the impact is less the magnitude.

Good, fair enough. Okay, so in a constant currency environment, given that we should see pretty much pass the anniversary of the biggest changes, do you think gross margin stabilizes in the current quarter or is it – do you think more of a March quarter?

Again, it always depends on the mix. I think that was on the average nine month and again based on the constant currency level today that should be the average gross margin that we produce. Again, there will be no M&A or something like that, but we change the lease of the revenue of the company.

Okay. One last question back to AT&T, I know you’re kind of searching to supplement that loss but do you have any insight on what they might be thinking and whether or not you think things ever come back with I think that’s all state?

No, the telecom industry went to crisis. So very honest to say right now we are leveling our budget and there is nothing going to change and no, hopefully something will be better, but we cannot bring them that positive change right now.

Are you trying to work with the consultants that you have there and maybe addressing some of the other issues that some of these telecom companies are working through like Wi-Fi solutions and…

Some of them already work for other companies and some of them we have to release because we don’t keep any bench.

Okay. Thank you very much gentlemen for taking my questions. I really appreciate it.

Thank you.

The next question is from of Jeremy Hellman of Singular Research. Please go ahead.

Thank you. And this is Debra filling in for Jeremy today. Thank you for taking my questions. I wanted to – I appreciated your comments earlier about the business pipeline and I wanted to follow-up if you could tell us a little bit more about your sales force and whether or not you are content with your headcount there, the number of people that you have in your sales team and whether or not you might be planning on adding to it?

So first of all in terms of sales guys, we always plan on adding sales guys. The main problem is that it’s very hard to find them. They are quite expensive especially if we talk about U.S. market and it takes us like probably between four to six months until we know whether it’s a good hiring or not. So the answer is yes, we always move to higher more sales guys, situation is that we are not that successful with that. Whenever we hire someone, there is always someone that is going to another company and therefore we are still around the same number.

Okay, all right, very good. So that’s a competitive field. And then I noted that you had announced - some months back, you had announced a new reseller arrangement. And I wondered if you could comment then on the reseller approach to tapping into the market to reaching customers. Have you added resellers recently and what are your plans for that particular channel?

So I think we are talking about - whenever we have time, we usually partner the pure reseller and we always look to add more [indiscernible]. On the integration side, we do quite well because of the demand to mobility and through the data more than you want, but didn’t reach our wall so we tend to recruit nice margin, but as you know we cannot announce all of them, some of them are always more, some of them are not interested in the [indiscernible].

Okay. So, do you probably added resellers and you are just not, they just don’t rise to the level or qualify for a press release, but you have been adding others to your roaster?

Yes.

And then also, I am just curious about how do you have your sales force and these of our relationships, are they focused on a particular Industry, are your sales people vertically focused, are they going out and reaching out to a variety of customer groups. I know you concentrated in communications, do you have sales people that are focused exclusively on the communications market.

First of all in the telecom market, we certainly have the people that are specializing on this market. I think all in all most of the sales guys are more kind of generic sales guys. Each one of them has its own know how and knowledge in what they say. Otherwise you cannot work in our industry, you need to be special people.

Okay. So, from your earlier comments about the competitive nature of finding qualified sales people, do you think that you are underrepresented in certain industries and are not maybe getting penetration because you just haven’t got the right sales person there?

Definitely. The sales team is very important and the fact that successful in keeping the number up in front of the bid.

Okay, very good thank you. And then just one last, maybe a little house keeping question, could you give us some guidance as to the split of the revenue along the three categories that you typically report in software maintenance and consulting services? How was that 45 million spread out amongst the three?

Basically, if you look at our performance story even on our annual financial statement you would see that we are approximately 30% in terms of enormous and 30% of our business is maintenance and in licenses pretty much divided 50/50 and the 70% portion of the business is professional services, but to that I would like to add that because we provide interim solution when it comes to an integration project or to software development projects sometimes we just don’t differentiate between the software side and the professional service side of the project. Normally, we tend to provide the discount over the price of the licenses in the software, basically because of call customer preference as long as the total price of the project keeps our guideline. So, if I divide the more generic professional services that I directly link to a software that we fail, I would say that the actual percentage between software maintenance to professional services of 60/40 towards professional services.

Okay, so this quarter it sounds like was very similar to the previous mix, is what you are saying.

Let’s say that this quarter it was little bit more to professional services, so we feel it is normally 30 to 70 this quarter it was 25 to 75.

Oh, 25 to 75, excellent. Thank you so much for taking my questions I appreciate it.

Sure.

[Operator Instructions] There are no further questions at this time. Mr. Bernstein, would you like to make a concluding statement.

Yes. Thank you guys for joining us to this call and hope to see you on our next call.

Thank you. This concludes Magic Software Enterprises Limited third quarter 2015 results conference call. Thank you for your participation, you may go ahead and disconnect.