Guy Bernstein - CEO Asaf Berenstin - CFO Amit Birk - VP, M&A and General Counsel

Tavy Rosner - Barclays Sarah Shizas - William Blair Kevin Dede - H.C. Wainwright & Co.

Ladies and gentlemen, thank you for standing by. Welcome to the Magic Software Enterprises Ltd. 2018 First Quarter Financial Results Conference Call. With us online today are Magic’s CEO, Mr. Guy Bernstein; Magic’s CFO, Mr. Asaf Berenstin; Magic’s Software Division VP of Technology & Innovation, Mr. Yuval Lavi; and Magic’s VP, M&A and General Counsel, Mr. Amit Birk. I would now like to turn over the call to Mr. Amit Birk of Magic Software. Please go ahead.

Thank you and good day, everyone. Our quarterly earnings release was issued before the market opened this morning and has been posted on the company's Web site at www.magicsoftware.com. Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements. The Safe Harbor provision provided in the press release issued today also applies to the content of this call. Magic expressly disclaims any obligation to update or revise any of these forward-looking statements whether because of future events, new information, a change in its view or expectations or otherwise. Also, during the course of today's call, we will refer to non-GAAP financial measures. A reconciliation schedule showing 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's Web site. I would now turn the conference over to Mr. Guy Bernstein, CEO of Magic Software. Please go ahead.

Good morning everyone and thank you for joining us today as we report our first quarter 2018 financial results. We are pleased to report a strong start to the year as we continue to experience consistent year-over-year organic growth in all of our financial indicators, including revenues, gross profit, operating income and net income. Fueled by demand to our innovative software solutions, Q1 revenue for 2018 reached a record 69.7 million reflecting 50% year-over-year growth, operating income for the quarter increased 19% year-over-year to a record 7.6 million and non-GAAP operating income increased 16% year-over-year to a record-breaking 9.7 million for the quarter. Our positive results and our increased share of the high growth integration market confirms that Magic’s diverse portfolio is providing the software and professional services needed by our customer base to transform their businesses to the digital world. Now, I would like to turn the call over to Asaf, our Chief Financial Officer, to discuss the financial results in more detail. Asaf, please.

Thank you, Guy. Good morning, everyone. Strong execution in the first quarter allowed us to perform in line with our annual guidance that we provided on our last earnings call. Our first quarter revenues totaled 69.7 million compared to 60.8 million for the same quarter last year, reflecting 15% year-over-year growth driven almost exclusively by our organic expansion. As of January 1, 2018, we are required to implement the new accounting standard ASC 606 regarding revenue from contracted customers. We adopted this accounting standard and do not expect any material impact resulting from the first implementation of the standard on our 2018 results. Looking at the geographic breakdown of our revenues, our geographic mix remains steady. North America accounted for 48% of total revenues; Israel 36%; Europe 10%; and APAC and the rest of the world accounted for 6% of our annual revenues. Most of our growth in the first quarter in absolute number was from North America and Israel which continued to be our strongest territories. North America accounted for 57% of our growth and Israel for 41%. Analyzing our revenue growth, our organic growth was approximately 81% accounting for 12% of our year-over-year growth rate. Turning now to profitability. Our non-GAAP gross profit for the first quarter of 2018 was 24.6 million, up approximately 15% compared to 21.4 million in the first quarter of last year. Our non-GAAP gross margin remains steady at 35.2% compared to the first quarter of last year and increased compared to 33.9% in the previous quarter. The breakdown of our revenue mix for the first quarter of 2018 was 28% related to our software solution and 72% related to our professional services versus 30% software solution and 70% professional services in 2017 as a whole. Moving to operational costs. R&D expenses on a non-GAAP basis in the first quarter of 2018 totaled 2.3 million compared to 2.9 million in the same quarter of last year. The decrease in R&D expenses is due to a strategic move to expand our offshore capabilities in India and St. Petersburg that will help us improve our profitability and margins going forward. Our non-GAAP operating income for the first quarter increased 16% to 9.7 million compared to 8.4 million in the same period last year. This reflects an operating margin of 13.9% for this quarter compared to 13.8% in the first quarter of 2017 and an increase compared to 13.2% in the fourth quarter of 2017. Our non-GAAP tax expense this quarter totaled 2.2 million representing an effective tax rate of approximately 221% compared to a tax expense of 1.4 million in the first quarter of 2017 reflecting an effective tax rate of 18%. We estimate that our effective tax rate for the full year of 2018 will range between 22% and 23% due to enhanced activity in the U.S. and in Israel. Our non-GAAP net income for the first quarter increased 7% to 6.2 million or $0.14 per fully diluted share compared to 5.7 million or $0.13 per fully diluted share in the same period last year. The increase in our net income is consistent with the above mentioned increase in our revenues and operating profit. Turning now to the balance sheet. As of March 31, 2018, cash and cash equivalents, short-term bank deposits and marketable securities amounted to approximately 87.6 million compared to approximately 90.9 million at the end of 2017. The decrease in our total cash is mainly attributable to a dividend distribution paid in the first quarter of 2018. Our total financial debt as of March 31, 2018 amounted to 37 million compared to 37.6 million at the end of 2017. From a cash flow perspective, we generated 7.3 million from operating activities in the first quarter. I would like to remind you that during the first quarter of 2018, we paid a cash dividend in the amount of $0.13 per share and in the aggregate amount of approximately 5.8 million for the second half of 2017, which reflects a dividend yield of approximately 3.2%. I would like to reiterate our 2018 full year revenue guidance which we expect to be in the range of 283 million to 293 million on a constant currency basis, reflecting an annual growth rate of 10% to 14%. Lastly, the company will be presenting at the upcoming Ladenburg Thalmann Technology Expo on May 31 at Convene in New York. With that, I would like to turn back the call to Guy for closing comments.

Thank you, Asaf. So in summary, we are pleased to report that Magic had its best quarter in the company’s history keeping us on track to meeting our annual guidance. Continuing the strong momentum for 2017, our fiscal year 2018 is off to an excellent start driven by the continued high demand in the market for our products and professional service in all of our regions. In keeping with our successful strategic direction, we remain focused on expanding our customer base as we continue to evolve our portfolio with powerful and innovative technologies in the fields of software application development, mobile, cloud, big data and especially in integration which I believe will account for the majority of any organization digital transformation effort. 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 Tavy Rosner of Barclays. Please go ahead.

Hi, everyone. Thanks for taking my questions. Guy, you mentioned increased demand for integration solutions and in the context of the recent acquisition of new stuff [ph] by Salesforce, I was wondering did you see any of the large corporate potentially acquiring Magic Software in the foreseeable future that’s something that could be – the takeover could be replicated for you guys?

Yes, definitely. There is a lot of interest around the integration technologies especially when you have a proven market. So here and there yes, we are being approached about the integration. I think it is too early to go for something like that. I think we have grown the integration side, we grow like quite aggressively and I think we should wait a bit more before we value --

All right, that’s helpful. And then you guys on your own acquisition in fact that you mentioned your net cash balance of 50 million. So do you have anything in the pipeline to consider inorganic growth?

You mean M&A on the integration side or --?

On your own side, yes.

Again, we are checking some – we did some transactions not specifically acquiring companies on the integration side, but we did something in order to get the first steps towards getting more integration technologies assuming those investments will mature.

Okay, that’s helpful. Thank you very much and good job and good results.

Thank you.

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

Hi. This is Sarah Shizas in for Bhavan. Thanks for taking my questions. It looks like overall gross margins picked up sequentially. Can you provide any color on the license services revenue mix during the quarter and how you expect that mix to trend over the remainder of the year?

With respect to our revenues, in this year basically the majority of the increase in our revenues came from the professional service side. This is why we feel kind of a – sort of a shift of 2% growing the operation of our professional services over the operations that we have on the licenses in the software solutions. Still on that note, we did see – we do see all the time an increase in our sales of integration licenses just this year and continuing to 2017. We managed to increase our integration capacity last year by 25%, this year at the beginning of the year we’re already improved the business by 15%.

Great, thank you. And can you provide any more context on what’s driving the growth in North America and Israel? Is it demand for particular product or seeing strength in any particular vertical?

I think it’s all over the place. It’s between organizations that are moving towards the digital world, a lot of integration stuff between on premise and off premise. You name it, it’s all over.

Okay. And one last one for me given the strong growth during the quarter and the demand you’re seeing in the market, is maintaining the revenue guidance 10% to 14% for the full year conservative?

It depends who you ask. If you ask me, it’s probably conservative. If you ask Asaf, then probably he would say we need to wait.

Okay, great. Thanks for taking my questions.

Thank you.

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

Thank you. Thanks for taking the call. Back to gross margin, it’s I guess intriguing that professional services increased, gross margin increased even though you would think there are more software renewals in the early part of the year, software license renewals. I was just kind of hoping you could put that in context for me.

If you look at 2017 versus 2018, then gross margin is pretty much stable. We’re at the 35% mark. Not that significant achieved. In Q4 of 2017, we had – as end of the year, we had some projects that didn’t meet let’s say the profitability that we expected there. And in the first quarter of 2018, we pretty much went back to what is our standard gross margin on our projects.

And when you talk about the renewals, it’s spread all over the year. It’s not something that you’ll see in the first quarter.

Okay. I thought most of them fell in the first half. Thanks, Guy. We can’t look into that and consider that maybe gross margin might suffer for the balance of the year?

Is that a question?

Yes, sort of a question. I’m just wondering I guess whether you want to confirm that logic or not?

I believe that 35% is the range where our gross margin should be this year.

Okay, fair enough. Thanks, Asaf. On the integration side and the cloud and the new software launch the second half of last year, I was wondering if you can give us any insight on how your customers are reacting to that and whether or not you’re seeing more implementations?

Okay. So on the integration side, we definitely – it’s something which evolves. Meaning, we see the customers all the time moving and dealing with integration issues and as a result you can see that we are doing well. The company is growing and we get a lot more projects. On the new product that we just launched last year, we see some first good signs; so yet to be seen. It’s building up.

Guy, are you happy with what you’re seeing? How would you characterize it versus your expectations and how would you characterize it versus competitive offerings that you’ve seen?

Okay, so you asked if I’m happy. Knowing me, you know that I’m never happy. I would say that in comparison to what we see in the market in terms of the technology, in terms of what’s going on, we do get nice achievements, the business is growing not bad. Of course I want it to grow faster but all-in-all, it’s okay. I cannot say that I’m not disappointed but I want to push the business further.

Okay. So now if I ask Asaf, Asaf’s going to tell me he’s happy because he’s made all the numbers.

Asaf is happy, yes.

Okay.

He’ll say even very happy.

I’m happy to meet your guidance.

So can you tell me how your marketing that capability and how your sales team is offering it not just to new clients – not just to existing clients but to new ones?

It depends. We’re working on online promotions. We attend of course the major ecosystem events. We are working together with ecosystem partners in order to promote our business through their channel. We have today something around 140 sales personnel that are doing the calls and doing the meetings. This is what pushes the revenues forward.

Okay. If I remember correctly though, Asaf, the focus for the cloud integration software isn’t really so much for existing clients as much as it is new ones?

That’s true.

Okay, all right. So can you speak a little bit to the shekel-dollar relationship? I know last year we saw some pretty good appreciation in shekel and I was wondering if you might expect that expenses sort of stay static at this level versus last year given the change in the currencies.

I think that today we need to remember that 35% of our business is coming from Israel. That means that 35% -- a significant portion of our profits as well are generated in Israel. The fact that we saw, let’s say, during the last month or so the appreciation of the U.S. dollar versus the shekel may impact our results but still I don’t think that that would have a material effect. On the other hand, we do see other currencies like the Japanese yen and the euro and the pound getting stronger compared to last year. So I think that all-in-all, the fact that we are still in some way diversified in the geographic that we are working that helps us to balance our exposure to changes in currencies.

Okay. As you look through the balance of the year, can you talk a little bit to how you see your – use of your resources? It looks like the first quarter was a little maybe heavier on professional services and I’m wondering where your headcount is on that and where you think it needs to be to meet the expectations that you’ve offered?

We have today 80% of our staff at professional services, around 1,600 employees. It has begun to be always a struggle to locate new employees, but we are working very hard in order to facilitate our ways to continue and grow the business. Let’s say that we don’t have any bench today but we don’t see or we didn’t see until now any struggle by recruiting new employees that holds our growth potential until now.

Okay. Just to confirm, Asaf, 1,600 total and 80% on professional services?

Yes.

All right. And you’re comfortable that you’ve been able to source the talent that you need to meet requirements?

Yes.

Okay. Thank you very much – oh, one last question for Amit. Amit, can you offer a little insight to the acquisition pipeline? I know it’s something you’ve been working on hard. And I know it’s an important component to your growth, it has been in the past. We haven’t seen anything I guess sort of headline. I’m just kind of wondering is it still sort of the same situation where sellers are demanding too high a multiple?

We have a few opportunities currently on early stage that we are reviewing and we hope that some of them we’ll execute it in the end. But as you know, we will keep once it will be closed.

Okay. And how about some of the deals that you’ve done more recently where you haven’t taken 100% position? Are you considering I guess wrapping them up so that they’re fully owned or --?

Always we have a call option but we are happy with the situation where the seller is holding some percentage that they have an incentive to run the business and to show a growth year-over-year.

Okay. Okay, gentlemen, thank you very much for entertaining all my questions. I really appreciate it and congrats on the nice job.

Thank you.

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

Thank you everyone for joining the call and hopefully we’ll bring you some more good news in the next quarters. Thank you.

Thank you. This concludes the Magic Software Enterprises Ltd. first quarter 2018 results conference call. Thank you for your participation. You may go ahead and disconnect.