Guy Bernstein – Chief Executive Officer Asaf Berenstin – Chief Financial Officer

Tavy Rosner – Barclays Sarah Shizas – William Blair Kevin Dede – Rodman & Rensahw

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Ltd. 2017 First Quarter Financial Results Conference Call. With us on line today is Magic CEO, Mr. Guy Bernstein, and Magic CFO, Mr. Asaf Berenstin. Magic's quarterly earnings release was issued before the market opened this morning and has been posted on the Company's website at www.magicsoftware.com. 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 company's 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 and change in its view or expectations or otherwise. Also, during the course of today's call, management will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press 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 Mr. Guy Bernstein, CEO of Magic Software. Please go ahead.

Thank you. Good morning, everyone and thank you for joining us today as we report our first quarter 2017 financial results. I will provide you with the highlights of our first quarter results and then turn it over to Asaf who will provide more detailed financial information. I will be happy to address any questions at the end. We are pleased to report a strong starts to the year with Q1 revenue reaching a record breaking $60.7 million, reflecting 36% year-over-year growth, a non-GAAP operating income increasing 20% to a record breaking $8.4 million for the quarter. With the strong trends in the integration of market, we continue to be recognized by top industry analysts for our leading platform offerings. As we increase our focus on the growing integration of market, we announced the now opening of R&D center in St. Petersburg in order to improve competitiveness and to shorten time to market. We also released Magic xpi 4.6. We expect users get even more value for more cost-free integration platform. These positive results contain that Magic's diverse portfolio is providing the software and services demanded by today's enterprise customers. We remain very positive about our ability to accelerate growth and ramp up operating profit in 2017. Now, I would like to turn the call over to Asaf, our Chief Financial Officer in order to discuss the financial results in more detail. Asaf, please.

Thank you, Guy, and good morning, everyone. Before I jump into our first quarter results, I would like to remind you that we are presenting our results on a non-GAAP basis, which as mentioned at the beginning of the call, gives a clear view into the operational state of the business and provides valuable supplemental information regarding our results of operation. There is a detailed reconciliation to non-GAAP results in the financial tables of the earnings press release. As Guy mentioned, our first quarter revenue was $60.7 million compared to $44.7 million for the first quarter last year, reflecting 36% year-over-year growth, with 10% growth compared to the fourth quarter of 2016. Analyzing our revenue growth, our organic growth rate was 18% accounting for half of our year-over-year growth, compared to the fourth quarter of 2016, all of our growth was organic. Together with the start of the anticipated renewal of software licenses among some of our larger enterprise customers, we were able to deliver positive results across all financial metrics. Looking at the geographical breakdown of our revenues, our geographic mix remains steady during the first quarter. North America accounted for 47% of total revenues, Europe which include Israel 46%, and APAC and the rest of the world accounted for 7% of our quarterly revenue. Most of our growth in the first quarter was from North America and Israel, which are strong territories for Magic. Turning now to profitability, our non-GAAP gross profit for the first quarter of 2017 was $21.4 million, up 21% compared to $16.7 million in the first quarter of last year. Our non-GAAP gross margin was 35.2%, down from 37.3% from the first quarter of last year and remaining 30% compared to the previous quarter. The decrease in our gross margin compared to the respective quarter, resulted mainly from the shift in our revenue mix from software towards professional services. The breakdown of our revenue mix for the first quarter was 31% software solutions and 69% professional services versus 35% software solutions and 65% professional services in 2016 as a whole. R&D expenses on a non-GAAP basis in the first quarter totaled $2.9 million compared to $2.3 million in the same quarter of last year. The increase in our R&D expenses is a result of our growing focus on extending our integration offering and from the recent addition of Roshtov to our business portfolio. Our non-GAAP operating income for the first quarter increased 26% to $8.4 million compared to $6.7 million in the same period last year. This reflects an operating margin of 13.8% for the quarter compared to 14.9% for the first quarter last year and 13.2% in the trialing quarter. The deduction in operating margin compared to the respective quarter is primarily attributable to the decrease in gross margin as I explained earlier as well as to higher R&D and SG&A expenses. Our non-GAAP tax expense this quarter was $1.4 million, representing an effective tax rate of 18% compared to tax expenses of $1.4 million in the first quarter of 2016, reflecting an effective tax rate of 21%. We believe that our effective tax rate for the full year of 2017 will range between 21% and 22%. Our non-GAAP net income for the first quarter increased 19% to $5.7 million or $0.13 per fully diluted share, compared to $4.8 million or $0.11 per fully diluted share in the same period last year. The increase in our net income is consistently with the above mentioned increase in our revenues and operating profit. Turning now to the balance sheet. As of March 31, cash and cash equivalents, short-term bank deposits and marketable securities amounted to approximately $99.8 million compared to approximately $87.8 million at the end of 2016. During the quarter, we raised $5.5 million in new bank debt to partially finance payments towards acquisition. The loans are based on new evaluation and are to be paid back on a monthly basis over a period of two to three years. Operating cash flow this quarter totaled $10.5 million compared to $12.2 million in the respective quarter. I would like to remind you that during the first quarter, we declared a cash dividend in an aggregate amount of approximately $3.8 million or $0.085 per share with respect to our 2016 second half results of operation, which was delinquency. This is in accordance with our dividend policy for our shareholders in which we return up to 50% of our net income in form of a dividend. Our current dividend yield is approximately 2%. Lastly, I would like to reiterate our 2017 full year revenue guidance which we expect to be in the range of $225 million to $230 million, reflecting an annual growth rate of 12% to 14%. With that, I will turn the call back to Guy for closing comments.

Thank you, Asaf. In summary, we are pleased to report a strong starts to the 2017 fiscal year with record breaking revenues and double-digit growth on both our top and bottom line. We saw positive results across all financial metrics due to continued solid demand through our products and professional services. We are confident in our growth strategy and remains focused on enhancing our portfolio, both organically and through acquisitions, to best care of our customers need for forward looking software solutions. With that, I will now turn the call over to the operator for questions.

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

Hi, everyone. Thanks for the presentation. First question, last quarter you talked about some deals – renewals of deals with the large enterprise that were taking some times to materialize. Is that something that you're seeing now as we've seen in the first quarter or looking into the second half of the year to have better visibility on the timing of those?

Yes. What we explained last quarter is that the renewals in some of the large customers that we have is – they are basically renewed in between three to five years, and every time the first year in software is a bit strong, a lack of renewals because based on the timelines of the renewal, the fourth year is usually weak. And yes, definitely we started to see it again. We already closed two of them and moving forward. So, yes, definitely, the answer is yes.

Okay. That's very clear. And looking at the margins, I guess this is the result of the mix probably more service oriented than software. Is that the mix that you expect to continue for the remainder of the coming quarters?

We push all the time to improve it a bit towards software rather than services, but we made good margin on services then we don't say no. I cannot fortunately, but we push for both, we are now focused on the software side.

Right. And then lastly if I may. Can you remind me what's the rational for the R&D facility in Russia that you open? Like what's the rational for opening? Is there, what capability does it add for the group?

We are trying to leverage. We already had a facility in Russia and that is dealing basically with the same start with business we have here. And we are trying to leverage on their capabilities because they know the – on the technical part, they are very good. And no need to mentioned that on the cost side is cheaper for us and we want to leverage on this one because we feel that we got lot of do in the integration market.

That's very helpful. Thank you, Guy.

Thank you.

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

Hi, guys. This is Sarah Shizas in for Bhavan. Thanks for taking my questions. Just generally, how is the overall demand environment for your integration platform? And then if you could provide any color on your mobile and cloud application business? How that trended during the quarter in kind of where you – how big of a portion of total revenue is that currently?

Okay. So along the integration side, we definitely see an improvement. No need to mention that the whole trend in the market with lately be the IPO of [indiscernible] is pushing a lot the industry and definitely we intend to push more on this one because at least on the technology side we feel that we have a lot to offer, nothing that is less than [indiscernible]. This is on the integration side. On the mobile side, we still see the demand as I mentioned all the time, most of the project that we see around the mobile, the vast majority of the money is not around the mobile itself, but in order to be here, you must see the check list. So a lot of the – I would say the features for the project are coming from the mobile side, but we are talking about big project.

Okay. Thank you and then, just quickly the update on the M&A pipeline, what are you seeing out there?

Currently we have like three companies that we are checking. We cannot say anything of that like in maturity stage that I can discuss about it. But also now we feel quite confident, because even without the M&A we feel quite strong on starting the year, but nothing to discuss yet about the M&A that we have on the table.

Okay. Thank you and then one last one if I may, just in terms of the verticals are you seeing any strength in particular verticals?

I believe on the integration side, we see some movements. All in all we feel that the business is doing better. We feel that more deals that we were working are becoming more mature and the cycle of closing deal is the shortening. We feel quite good about going forward.

Thank you for taking my questions.

Thank you.

Next question from Kevin Dede of Rodman & Rensahw.

Thanks for taking my questions too. Couple of things, listen you probably shaped it so well in the March quarter that it – your expectation for the balance of the year seem to be ultra conservative and I'm just wondering you know what you are seeing versus what you really feel comfortable communicating. It just seems to me based on sort of low double digit growth as you posted through the four quarter last year, that you could easily surpass the top of your guided range. And I was just wondering if you wouldn't mind talking to that little bit please, Guy.

So, first you are right, we are being a bit over conservative. We said that in Feb as you know running and upgrading the expectation. We want to go deeper into Q2 and then kind of feel more comfortable to come up with new expectations. At the end, yes, we are conservative.

Okay. Fair enough. Thanks very much.

I don't want to be in a position where I'm running to upgrade the expectation and struggling to deliver, because it's…

No, no, I understand. But to your point Guy, we're half way through Q2, we're almost – you should be able to see pretty much the half way mark for the year.

Kevin, on that aspect I don't think that even – that in terms of longitude, we are ultra conservative. I think as Guy has said, we are conservative. As you see that, we have lots of project that are being done on professional service side and we have significant amount of business, 35% of business today we think is out from Intel. This quarter anywhere there were no vacation, now holiday season in Q2 for example, we have the April holiday Jewish holiday, Passover that would impact our result revenue to some extent. So, in terms of our focus for the end of the year, even if we will take that and I'm sure that we will, it will be in a couple of percentage, so on that nothing that we are ultra conservative.

Okay. Thanks Asaf. Guy, you know I think this whole trend toward integration is really interesting and I think it especially given the strength in your service business, I know it was tough there, it was off date for a while, but it seems to me that you've got that realigned and now you've got this other driver and the integration, and I was wondering if you wouldn't mind talking a little bit more about xpi 4.6, the fact that it's code free and how you see it, because you mentioned that you see it technically superior to recent competition. And I'm wondering if you wouldn't mind adding a little more detail about that and specifically with regard to the length of those projects.

So, I will try to put it simple, the idea behind the xpi advanced that you can just put it as a heart in the organization and you can drag and drop between old platforms or servers or whatever you have there in a very graphic way. You don't need to be an IT expert in order to integrate between OPA and the systems and I think one of the things that we bring to table, and on top we mentioned this, on the services side, is that you know everyone is talking about integration solutions from the cloud and from ADN, the big project coming from legacy environment with big organization and this is where we are added to. On top of course we are providing class solutions as well, but the dominant triggers addressed are coming from legacy environment. And I think this is environment that we understand very well. Is that clear?

Yeah. So, could you just, I mean I'm sure you've seen in the software that IPO and I'm just wondering where I mean – you spoke to your advantages and I just wanted to make sure that I understood them specifically?

It's about the advantage of going across the board. You know it's like there is nothing that add-in such a new capacity, we don't is one thing. The other thing is, I think we in many cases we come up with readymade solutions for specific environment and ecosystem so I'll give you an example, if you know a common integration is between whatever SAP and Salesforce or S&P and SugarCRM or JBE, so we have all of those rights, part of the most playing, you can just plug and play. It's nothing that you need to do and play with the technology in order to make is work. And we have a lot of experience with it. So, I think in general, the understanding of the market where we are in this market I think we are – it's for a reasons that we are highly appreciated by the top industry analyst.

Would you say that you have that same flexibility across an Oracle platform that you do in SAP?

Of course.

Okay. Fair enough. Thank you.

This is where we started with the flexibility. Being agnostic on the platform without it.

Okay. Because we are tended to pay our xpi tool, contains more than 100 different types of connectors to different systems that are out there, so of course they relate also to that.

Asaf just on SG&A for non-GAAP kind of big pick-up and I'm just wondering how that – what's the variable component of that expenses and how it ties to revenue?

First of all we have additional workforce that are being added mostly in our sales force. And in that aspect we are investing in our marketing, we are participating in expeditions and all that aligns with putting our product and our integration platform ahead. All of that brings up our level of expenses. G&A to that expense, if you would measure our G&A – our SG&A as a percentage against our revenues, you would see that they are even dropped by approximately 1%. So they are growing in line with our revenues, but are still in a lesser extent.

Do you see that balance sort of fairly consistent for the year, just what's your view on your future expense there?

I think that as a percentage of our revenues, we will be staying at the same level.

Asaf, you went so quick on the mix between software and service and you know March 2017 versus March 2016. I apologize for asking for this, but would you mind just repeating those figures for me please?

It's 31% for software solutions versus 69% for professional services.

Okay, was that the same?

In 2016 as a whole, we were 35% on software solutions versus 65% on professional services.

Well, hey guys, great job in the quarter. Thank you very much for entertaining my questions.

Thank you.

Thank you, Kevin.

[Operator Instructions]. The next question is a follow-up from Kevin Dede.

I figured that there's nobody else who is going to ask. Could you just sort of talk a little bit about the debt level versus cash? I know you spoke to paying your dividend, but it just seems that given that there is nothing pressing in the M&A pipeline, I'm just kind of wondering what you are thinking?

First of all we think that interest rate are very cheap today, so as you can see whenever we take loans for maturity of between three to seven years, we took around $32 million worth of loans in Magic. We have some entities in which we are partner with the founders and whenever we do acquisitions to grow the business from their organizations and we prefer to take levels that is being let say balance between us and the founder. That on one hand, on the other hand again if you look at 2016, you will see that we did approximately four to five acquisitions. So, for us it's you know it's better to be prepared to do – to be prepared with the cash on hand rather than once you have a deal and got and start running up the deal after the cash.

I will try and make it more clear. Whatever we generate as cash is more than enough to pay the dividend and to deal with the – I will say small acquisition that we do here and there in the subsidiaries. We still keep the level of quite high cash, because we still look for the next big thing that we can leverage on and acquire and I think this is the reason behind it.

Okay, Guy, that's consistent with commentary in the past. I appreciate that. I guess the big question is, given that there are always things that you are looking at. I'm just – and I know you said there is nothing pressing. I'm just wondering, typically valuations are at least through most of last year. You clearly got a lot of stuff done last year, but there was a thing that you are looking at that you didn't get done. I'm just wondering if you could speak to valuations in light of IPO activity.

You are talking about valuations about the Company that we checked, the Company we are checking?

Yes sir.

So, it varies between companies that are dealing with technology or companies that are dealing with professional services of course. There is nothing to compare professional services. Again, if we usually, we are trying to go for unique skews that will complete our offerings and yet again on the professional services, I think we do quite good acquisitions. We buy them rather cheap. On the technology side, it's more tricky, because if you go for mature businesses with high volume, usually they have banks to represent them and prices are quite high. This is the main reason why till today we didn't do something significant on the technology side. On the smaller companies, we tend to bring them to reasonable prices and then it differs between young companies that you know they think they have a bright future and usually they want to see higher valuation. And I will say, probably all companies are mature companies that understand that they have this feel that you know they reach to a certain level and from here on they will need to partner with someone bigger that can take them to the international road. By the way we are in some discussion with very interesting companies right now, that are in the exact position, meaning, it's a nice company, profitable, but it's very local in Europe and you know it's clear to them and for us that together we can bring it to the next level. Still there is a gap in terms of what we are willing to pay and what they want to fix. So, on the technology side I would say it's not easy.

Right. And if I remember correctly, you made acquisitions, it's more to the one that you just spoke to early last year, a small Israeli company mainframe including didn't have access to the grand global market and you were able to do that. Is that true?

Yes. That's absolutely correct. Now we're talking about a different company in Europe.

Right. Okay. So, just to reaffirm what Asaf mentioned, you were able to finish four or five last year, or closed four or five acquisitions?

Yes.

Okay. And then Asaf spoke to organic growth?

18%.

18%. Okay. Well thanks very much gentlemen. Appreciate you entertaining the questions and congrats again.

Thank you.

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

Yes. Well thank you very much all for joining us this time and I hope we'll bring you some more good news in the future. Thank you.

Thank you. This concludes the Magic Software Enterprises Ltd. First quarter 2017 results conference call. Thank you for your participation. You may go ahead and disconnect.