Ladies and gentlemen, welcome to Magic Software Enterprises 2019 Third Quarter Financial Results Conference Call. [Operator Instructions]With us on the line today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's CMO, Mr. Einat Etzioni; and Magic's VP M&A and General Counsel, Mr. Amit Birk.I would now like to turn the conference over 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 open this morning and it has been posted on the company's website at www.magicsoftware.com. Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements. The Safe Harbor provision provided in the press release issued today also applies to the content of this call. Magic expressly disclaims any obligation to update or review 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 open this morning. A replay of this call will be available after the call on our Investor Relations section of the company's website.I will now turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

Thank you. Thank you, Amit. And thank you everyone for joining us today as we report our third quarter 2019 financial results.We enter the second half of 2019 with the third pipeline of business, which we expect will serve our continued strong momentum into year-end. Our third quarter results demonstrated the continued solid execution of our 2019 priorities of top line growth, while maintaining our operating margin.Our first quarter revenues totaled $85.8 million compared to $72.1 million for the third quarter last year and $77.1 million in the previous quarter, reflecting 19% and 11% growth respectively.The outlook for our business remains robust and we are benefiting from global trends that are driving our growth. This includes, first and foremost, the demand for wide range of top technologies, methodologies and services for the SMB enterprise digital transformation demand for services. On the M&A front, Magic has demonstrated a solid track record of acquisitions that have accelerated top line and bottom line growth.We have proven our ability to successfully integrate acquisitions and improve the operational performance of the combined entities. Through our acquisition strategy, we have expanded the offering for our customers and increased our global footprint.Our recent acquisitions completed during the third quarter NetEffects, a U.S.-based company which specializes in IT staffing and recruiting will expand our footprint in the U.S. market and diversify our client portfolio. NetEffects team and its solid customer base that includes several blue chip companies will help Magic fulfill its commitment to its client to serve as a one-stop-shop for a full set of solutions and continued its expansion.We continued with the efforts to find more potential companies that fit our strategy in evaluation range. We continue looking for small to mid-sized companies with revenues in the range of $20 million to $60 million which will follow our strategy, geographic expansion, complementary products and customer base.On the marketing and brand awareness front, we continue to focus on two fronts on our software solution division, the low code application development and Industry 4.0. In the beginning of the week, we hosted our Annual Japanese Partners and Client Conference in Tokyo, more than 500 participants representing 250 ISVs in enterprises that include several blue chip companies discuss the Japanese industry trends at Magic strategy vision enrollment.We believe that the Japanese market serves as a growth engine for Magic as it is the fourth industrial nation in the world and is the leader in adoption of low code and mobile development platform.Turning now to our third quarter business performance. I will now review our non-GAAP results followed by comments on the balance sheet, cash flow and end with our 2019 revised outlook. Looking at the geographical breakdown of our revenues during the third quarter. North America accounted for 48% of our total revenue, Israel 37%, Europe 8%, and APAC and the rest of the world accounted for 7% of our annual revenue.Most of our growth in 2019 in absolute number was traditionally from North America and Israel, which continue to be our strongest territories. North America accounted for 40% of our growth for the nine months and 36% in the third quarter, and Israel accounted for 52% of our growth for the nine months and 59% in the third quarter. Our revenues in North America for the nine months period grew 9% year-over-year, and our revenues in Israel for the nine months period grew 17% year-over-year.Turning now to profitability. Our non-GAAP gross profit for the third quarter of 2019 was $28.9 million, up approximately 26% compared to $22.9 million in the third quarter of last year. Our non-GAAP gross margin for the third quarter of 2019 equates to 33.7% compared to 31.8% in the third quarter of last year. Our non-GAAP gross margin for the nine month period of 2019 remains at 33.4% compared to 33.5% in the same period last year.The breakdown of our revenue mix for the nine-months period of 2019 was approximately 26% related to our software solution and 74% related to our professional services compared to 28% related to our software solution, 72% related to our professional services in 2018 as a whole. The decrease in the percentage of our software solutions is due to the acquisition of NetEffects and the expansion of our professional services portfolio.The breakdown of our gross profit mix for the nine-month period of 2019 was approximately 51% related to our software solutions and 49% related to our professional services, same as in the respective period last year.Moving to operational cost. R&D expenses on a non-GAAP basis in the third quarter of 2019 totaled $3 million compared to $2.1 million in the same quarter of last year and $3.2 million in the previous quarter.The increase in our R&D expenses related mainly to the first time consolidation of PowWow. As evidenced in many other software development companies in recent years, Magic has also been moving into development efforts to India and open a new R&D center in St. Petersburg to support its growing base of global customers.These centers which currently employs close to 400 employees are aimed to help us drive innovation and provide support for new and existing projects across our product portfolio, providing scale to our organization with an efficient cost structure and is critical to our support of - future growth.Our non-GAAP operating income for the third quarter increased 18% to $11.8 million compared to $10 million in the same period last year. This reflects an operating margin of 13.7% for this quarter compared to 17.8% in the third quarter of 2018 and 13.9% in the second quarter of 2019.As earlier stated, our results for the quarter included for the first time the consolidation of NetEffects, our recent acquisition which is accretive to our results.Our non-GAAP tax expenses this quarter totaled $1.4 million compared to a tax expense of $1.6 million in the third quarter of 2018. Our effective tax rate for the nine-month period of 2019 was approximately 16% compared to 18% in 2018 as a whole. We estimate that our effective tax rate for the full year of 2019 will range between 19% and 21%.Our non-GAAP net income for the third quarter increased 19% to $8.1 million or $0.17 per fully diluted share compared to $6.8 million or $0.14 per fully diluted share in the same period last year.Turning now to the balance sheet. As of September 30, 2019, cash and cash equivalents, short and long-term bank deposits and marketable securities amounted to approximately $100 million compared to approximately $116 million at the end of the previous quarter.Our total financial debt as of September 30, 2019 amounted to $28 million. From cash flow perspective, we generated $6.1 million from operating activities in the third quarter and $32.7 million during the nine-month period of 2019.In summary, this quarter's strong financial results demonstrate that Magic is continuing its impressive forward momentum with growth in both revenues and profit. A record-breaking nine-month results for 2019 confirm that our strategic business initiatives are paying off. I would like to turn now to our guidance for 2019.Looking out to the reminder of 2019, we anticipate continuing with our growth momentum and are increasing our full-year 2019 revenue to the range of $317 million to $320 million compared to our previous guidance of $313 million to $319 million.With that I will turn the call over to the operator for questions.

[Operator Instructions] The first question is from Maggie Nolan of William Blair. Please go ahead.

I'm wondering how much of contribution NetEffects had in the quarter and what you expect that contribution to be going forward?

Basically, during the quarter the contribution to the top line was around $5 million. This is the current run rate. But we believe the projections for next year should be up by between 8% to 10% at the moment.

And you said it was accretive to the business. Do you expect that to continue, are there any investments that you think you need to make while you're integrating NetEffects?

No, I think - first of all, it is accretive now and it will be accretive in the future. We are currently also doing - as we always do implementing synergies with our other operation in the U.S. in order to improve its profitability.

And then the comments at the beginning, you all sounded fairly positive on the pipeline, can you give us a little bit more detail about how that pipeline looks versus prior years? And if there is any change in terms of what you're seeing in the way of deal size or deal length?

I think that's basically - it's more to the fact that the first half of the year begun for us pretty slow. We experienced some slowdown from at least against - versus our expectation from CVS, which is our largest accounting that the fact that we added NetEffects is one of the reasons or examples for our wish to diversify our customer portfolio, and let's say, be less sensitive to changes in significant clients.We started the second half with some nice projects that were hooking during the first - during the first half, and from that we are - this is why we are more positive and with - what we would expect from the second half versus the first half. I would mention one thing that, again we have 40% of our business coming from the Israeli market and Israeli market in fourth quarter will have it's annual holiday.

Holiday.

Holiday season, which also will have a negative impact of around 6% of the revenues of the - coming from Israel during the fourth quarter. And by that we still believe that we managed to compensate with other activities, which are more worldwide.

I think all-in-all we see a global trend that - there are way more investments into this digital world and therefore more projects, bigger sizes of projects and we definitely enjoy that.

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

Congrats on the strong results. You mentioned NetEffects. Can you comment on who their customers are and what kind of traction you expect to get from them in the coming quarters?

Basically, I'm not in liberty to mention the names of the customers. We just - you know - first started this - let's say, working together with the management there during the June, July. They have some blue chip companies, they have - they are showing a growth projective when looking at the last, let's say, two years to three years operation. We believe that together with our presence in the U.S. market, we can even contribute more to the growth.But in terms of Magic, it's not a large company. As I said, they only contributes like $5 million per quarter at current level of the operation, they have around 20 - 25 customers with - like half of this - half of them contributing around 70% of the revenues.So I don't think that by the name, Mastercard for example, is one of the customers bill buyer. So, is another - say is another customer of them which have, again, large accounts. So I don't think it's an issue to mention them.

And then you talked about Japan, which is interesting because it keeps on coming on the radar when you're talking about Industry 4.0. And what percentage of revenues do you currently have in Japan, how big do you think it can get based on what you're seeing there at the moment?

I think, currently Japan is not that big in terms of revenues though it's a pure technology sale and it's a different way of doing business in Japan, everything is through ISVs. And we definitely see trend in Japan in the past two years of growth. So, we don't know exactly what to expect for the next year, but it looks quite positive, right now.

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

Thanks for taking the question. Last question on NetEffects, what and how did you pay for $20 million in annual service revenue?

It's a complex deal. But I think the down payment is like $9 million with some earn-out over the next three years. So this is - all-in-all we will, we should pay if everything goes well, probably $12 million.

$12.5 million and we get also - we are also paid for the working capital of around $4 million, which we're getting the company from the first day. So this is why the company is also accretive on - not just on the P&L, but also on the cash.

So when did it close. I mean, are you seeing the full effect of it in the September quarter?

Yes. It closed beginning of - very early in July. And this is why we've also mentioned it in our previous conference call.

Right. Okay. Okay. About how many - about how many heads, how many service heads came with the deal?

Yes, close to 200.

So where does that put your total service head count?

We have today around 2,600 employees and in terms of most of them of course from the - for professional services, around 80% are professional services basically.

Now I understand, Asaf, you mentioned CVS, can you just sort of give us a little bit more color on what's going on there. I know that there was some pressure on margin, but I was just hoping you could dig in a little bit on the rebate side?

I would say, on CVS, its kind of double sold on one hand - from the merger that they had with Aetna, we do see some more business coming from Aetna one side. On the other side, we did see an experience - a decline in the budget. So, in comparison to last - in comparison to last year, we lost around $5 million in terms of terminals of third quarter.On the other hand, it's true that, if you take a company, for example, like NetEffects, which has a lower level of revenues versus what we get from our operation in CVS, still the fact that they are not that big in the customer site, it gives them the ability to benefit from much higher margins as - with CVS, we get more aggressive, let's say in rebate mechanism.Still we are very glad to the business that we get from CVS. This is a long-year relationship that we have with them, and you know cooperation is good. I'm sure that you know once - let's say, all merger activity will end, we will continue to see business back from them in the future.

Asaf, you also mentioned development in India and St. Petersburg. Can you, can you talk to, I guess what drew you to trying to develop software in Russia and how you see the business arrangement and the political environment between Israel and Russia?

So I would answer that. First, we in the past, we acquired a company that had an operation in St. Petersburg and therefore we have our own people working with us for many years. So we have the experience with them. I don't think the political situation is influencing whatsoever. I must say that they are way cheaper than what we can find in Israel or in the states. And in terms of capability, you can find a lot of talent over there. So overall, the balance is working for us.

Can you give us a ballpark on like how many people you've got there versus the rest of your R&D team?

As I said, in total between India and St. Petersburg, we are close to 400 people.

So Asaf, SG&A popped up in the third quarter versus the June quarter. Is that a function of net effects and what sort of back-office synergies do you think you can manage to that integration and where do you think that goes?

Well, I think - basically more than 50% of the growth in our G&A came from the acquisition of NetEffects. I think that basically on synergies, our contribution what we believe in the sales - in the sales mechanism in the rest of the fact that we came back - the growth of the company which until today, - it was held by a private individual which you know, normally they tend not to risk their own funds. Now the fact that we can support the growth and increase the working capital capabilities will assist in the growth.On terms of synergies, I don't think that that growth will cause to - let's say - will bring to additional increase in the OpEx except for sales expenses. So I think that we. With that, both the increase on revenues and both the fact that we can support them on that growth will not expand the G&A, and with that will improve the margins.

Yes, I understand. I was just wondering, I mean, on a non-GAAP basis it's almost $15 million. I was wondering if you think there is cost that you can extract and what do you think that number goes to say in fourth quarter?

I don't think that would be immediately beginning of the fourth quarter you will see a dramatic change, something in the range of few hundred thousand dollars that I do expect to see all areas savings in the fourth quarter.

On other partnerships that you have, could you talk a little bit about your arrangement with Tata analytics and where you see your business growing there by geography and what sort of other accounts, you think they can drag you into?

We are again, Tata is not a partner of ours, mainly not one that - you know that significantly has - even if we are working within them, that have any significant on our business opportunities.

Okay. I guess I misunderstood that. Apologies and thanks for clarifying for me. All right, so, also on the P&L, if I understood correctly, you expect the full-year tax rate to be 19% to 21%, is that correct, Asaf?

Yes. We are currently at 16% level for the nine months, but let's say that we do manage out of the acquisition that we did with NetEffects, the fact that we can implement some tax saving initiative with the way that we report this acquisition as - if we bought the assets of the company rather than the stock and the fact that we follow, we can also utilize some of their NOLs and the fact that we can also do some initiative in - let's say moving the IP of Powwow from U.S. in Israel that came - that was the main driver that reduced our effective tax rate in 2019.Currently, as we feel still fresh both the acquisition of Powwow and the acquisition of NetEffects. And the fact that we are still working out - let's say the details - the tax details with our tax advisors. I wanted to be more - let's say, careful in conservative, and this is why I kept the range something between 19% and 21%.My expectation is to be lower than that, let's say, for the year-end. If you won't be - the numbers that will represent next year like 2020 that's the range 19% to 21%.

Okay, last question, you mentioned 51 software solutions and 49% professional services, but I got confused. I wasn't sure if that was a breakdown on gross profit or in revenue?

That's the breakdown of gross profit. So despite the fact that the software division is around 30% of our revenues, it still contribute like half of our gross profit.

Could you review the revenue breakdown?

It's basically, we do - again, no change. As I said, 26% of our revenues is from the software division, 74% is from the professional services, basically that’s that.

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

So, thank you very much for joining our call this quarter and we hope to bring you some good news in the next quarter. Thank you.

Thank you. This concludes the Magic Software Enterprises Ltd. third quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect.