Magic Software Enterprises' (MGIC) CEO Guy Bernstein on Q2 2014 Results - Earnings Call Transcript

Aug.11.14 | About: Magic Software (MGIC)

Magic Software Enterprises Ltd. (NASDAQ:MGIC)

Q2 2014 Earnings Conference Call

August 11, 2014 10:00 AM ET

Executives

Amit Birk - VP, M&A and General Counsel

Guy Bernstein - CEO

Asaf Berenstin - CFO

Analysts

Bhavan Suri - William Blair

Kevin Dede - H.C. Wainwright

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Magic Software Enterprises Ltd. Second Quarter 2014 Results Conference Call. All participants are present in a listen-only mode. Following management’s formal presentation, instructions will be given for the question and answer session. (Operator Instructions) As a reminder, this conference is being recorded August 11, 2014. With us on the line today are Mr. Guy Bernstein, CEO; Mr. Asaf Berenstin, CFO; and Mr. Amit Birk, VP, M&A and General Counsel.

I’d now like to turn the call over to Mr. Amit Birk of Magic Software, please go ahead.

Amit Birk

Thank you and good morning everyone. Our quarterly earnings release was issued before the market open 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 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, in change in its view or expectations or otherwise.

On this call today, we will provide you with details about our performance in the second quarter and third part of 2014, including certain non-GAAP financial measure. We provide non-GAAP financial measures because we believe that they are the most valuable ways to review our core operating results. We’ve provided a reconciliation of non-GAAP measures to their 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 Web site. Now I will turn the call over to Guy.

Guy Bernstein

Thank you, Amit and good morning and thank you everyone for joining us today as we report our second quarter 2014 and first half financial results. I will roll over the highlights from the second quarter and give some insight into our focus going forward and then turn in over to Asaf, who will provide a deeper dive into the numbers.

Simply put, we are very pleased with our results for the second quarter and first half of 2014 showing steady growth in both of top line and bottom line. This growth is a result of increased demand for our products and professional services, cost saving actions and increased operational discipline.

Revenue in the second quarter reached 40.6 million an increase of 17% year-over-year with non-GAAP net income of 4.7 million reflecting an increase of 24% over the prior year. Our products are well positioned to enable enterprises to leverage the growing trend of enterprise mobility and application integration and with a strong cash position of approximately $93 million, we continue to identify and evaluate acquisitions to expand our footprint and to enhance our software imaging portfolio.

I would now like to turn the call over to Asaf Berenstin, our Chief Financial Officer to discuss the financial results in more detail. Asaf, please.

Asaf Berenstin

Thank you, Guy. Today, we will be underlining our results on a non-GAAP basis which as mentioned at the beginning of the call better conveys the operational state of the business. There is a detailed reconciliation to non-GAAP results in the financial tables of the earnings release. As Guy mentioned, our second quarter revenue was $40.6 million up 17% compared to steady 4.8 million for the second quarter last year.

Our non-GAAP gross profit was 16.7 million up 12% compared to non-GAAP gross profit of 14.9 million in the second quarter last year. Non-GAAP gross margin decreased to 167 basis points to 41.2% resulting from the bringing of the consulting services, our latest acquisition into the (fold) [ph]. All states contributed much of the growth to our professional services sales this quarter.

Our non-GAAP operating income for the second quarter of 2014 was $6 million or 15% operating margin up 28% compared to non-GAAP operating income of 4.7 million or 13% operating margin in the second quarter last year. Our GAAP net income was $3.9 million or $0.09 per fully diluted share based on 44.5 million fully diluted shares outstanding, up 11% compared to GAAP net income of $3.5 million or $0.09 per fully diluted share based on 37.2 million fully diluted shares outstanding.

Here I would just like to remind everyone that the share count increased as a result of our recent $55 million public offering. Our non-GAAP net income was $4.7 million or $0.11 per fully diluted share, up 24% compared to non-GAAP net income of 3.8 million or $0.10 per fully diluted share in the second quarter last year.

Turning to the balance sheet, we ended the quarter with $92.8 million in cash and short term investment compared to 87.9 million as of March 31, 2014. Operating cash flow for the first half of 2014 was approximately $12 million, higher than our non-GAAP net income for the period. Our strong financial profile including strong free cash flow enables 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. At the moment our dividend yield is approximately 3.3%. During the first quarter we distributed $4.5 million or $0.12 per share with respect to our 2013 second half results and in accordance with our dividend policy.

At this time we are providing full year revenue guidance, while we are not providing guidance relating to our profitability, we say that we have been profitable since 2006 and have been consistently increasing our operating income year-over-year. In the previous quarter we announced that we expect full year 2014 revenue of approximately 161 million to 165 million with our first half revenue at 81.6 million we are currently on target to meet this goal.

With that I will turn the call back to Guy, for closing comments.

Guy Bernstein

Thank you, Asaf. In summary, we had a good and profitable quarter in Magic’s products and services are very relevant to today’s enterprise market. We are upholding our growth strategy by enhancing our existing products, strengthening and expanding our strategic alliances and partnerships around the world, leveraging upsell and cross-sell opportunities across our businesses and expanding our product portfolio through M&A activities.

With that, I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question's from Bhavan Suri of William Blair. Please go ahead.

Bhavan Suri - William Blair

Hey guys, nice job there, just a few questions as regards for everything is pretty clean but you obviously had nice upside in the quarter and I’d love to get just a little color of what specific parts did you see outperform your expectations, was it sort of on the license side and was it sort of cloud based mobile, the traditional offering, the integration, how would we think about that in terms of what you see client interest around?

Guy Bernstein

I think that we see a lot of interest around the mobile offering, I think as a result, not only that we feed mobile deals but I think as a result of the mobile offering we get a lot upgrades and updates for enterprises and partners that prefer themselves for the mobile opportunity. So, it’s not that we see yet big money from our mobile platform but we definitely see some trend in the market.

Bhavan Suri - William Blair

Great Guy, and then as you look at the pipeline and if you were to compare the pipeline from a year ago, give us sense of sort of the types of deals we are seeing in the pipeline and a little bit maybe a color of how that pipeline has grown over the year?

Guy Bernstein

Okay, so I think if I compare it to last year then we see way more deals in the pipe. I think in terms of size, if you relate to the mobile platform then the size of the deal is not big but as a result as I mentioned before we get a lot of bigger deals on the technology side not necessarily the mobile side.

Bhavan Suri - William Blair

Got it, and then when you look at the gross margins that are down year-over-year but they were better than what we’ve been expecting. When you look at the mix that you had from services versus product, new engagements around mobile versus existing, where would you say the upside and this might be for Asaf a (little bit) [ph], what would say the upside came from?

Asaf Berenstin

If we are speaking about by the way about the first six months of the year then practically we saw improvements in all different aspects of our offering, meaning we saw improvements in our sales of software, in our licenses and technology products and we saw the same increase also in our professional services. The main differentiator that brought our gross margin a little bit down this year versus the respective period is because of the mix of revenues as we incorporated all states which was acquired late November 2013, in to the fold.

Bhavan Suri - William Blair

Okay and then just two more from me. One on the partnerships obviously the partnerships with the software houses is a great way to sort of deploy the product but can you talk a little bit about the partnerships with some of the other third parties Guy and sort of how are those progressing because obviously you guys laid out a plan and the deal to sort of enhance that and broaden the sort of awareness through that partnership channel, just a little bit around how that’s progressing will be great?

Guy Bernstein

I believe you refer to the ECOC systems we work in.

Bhavan Suri - William Blair

Yes.

Guy Bernstein

So as you know, in some of them it's real partnership and some of it’s like we feel some of the business strong then because they have their solutions, but in both cases I think we see an increase in all aspects. We are getting better in terms of our -- if we talk about solutions to the cell phones equity spend or to the SAP equity spend we see more and more deals and bigger deals.

Bhavan Suri - William Blair

Okay. And then last one just touching on acquisitions, you guys haven't -- you made one in November obviously but sort of just a little color on sort of what you’re looking at for M&A, what might seem interesting to you and what is the pipeline for deals look like on the M&A side?

Guy Bernstein

In terms of what we look for we said earlier that first and foremost we would prefer to see an acquisition on the technology side, especially if we can leverage these through our partners and channels and everything. Unfortunately when you talk about such acquisitions it’s way more expensive and way more how to fund.

Bhavan Suri - William Blair

The multiples are out there?

Guy Bernstein

Yes. On the professional services side, I think we look for things that are kind of more unique not just the generic type of services, because at the end we want to increase the margins rather than to push them down.

We also do look for some of our partners as we mentioned through the deal to go after some of our partners that have stable business with interesting applications.

Usually we are talking about small businesses but rather profitable, stable with good maintenance (win) [ph] that we can usually buy for good prices and kind of take them global and this is the upside we bring to the table. At the moment we have I would say two relevant acquisitions in the pike that I think we'll be able to close hopefully, other than that we have a few at any given moment but I cannot say that there is something serious. It's still in preliminary stage.

Operator

The next question from [indiscernible]. Please go ahead.

Unidentified Analyst

Hey guys, congratulations on a good quarter and thanks for taking my question. It will be helpful I think for a little more color on the types of end applications you’re seeing in mobile. It sounds like you had a little bit of upside this quarter from mobile but those are smaller deals, pipelines sound very solid as well, maybe just a little bit of color I think would be helpful on the types of applications you’re seeing around your mobile offering?

Guy Bernstein

In most cases because we -- well first and foremast, we approach our partners and the channel that we work in, in most cases you will see applications that are quite connected to the existing core applications that they have. So in most cases you will see applications that they want to expand to mobile devices, things that are connected to what they do. On top I can say that in most cases kind of first stages when they start with some on a small scale in order to try it and we definitely expect them to expand. This is the majority of the deal that we see.

Unidentified Analyst

Okay, okay. That’s helpful thanks. And then I think also on the cloud I know that’s really your stage but are there certain types of cloud applications that you’re seeing? Are their hired clouds, private clouds and maybe even a little bit further up the application stack what exactly are you seeing customers adapt to your cloud offering for?

Guy Bernstein

I think in most cases we are talking about private clouds. Here and there for new players they go after the public clouds for their niche applications, but all in all what we see is definitely a trend into the cloud space we see that all partners that we work with the big one such as Microsoft, Oracle and the rest of them IBM, they are all pushing quite strong to the cloud space. I can tell you that for example in Microsoft they shifted the whole business to Azure, and they are quite aggressive on it. So, it’s definitely a sign and of course it will cause a whole change for the business model for all of us.

Unidentified Analyst

Okay, great and then -- on Allstates I know you’ve got a couple of quarters under your belt, how would you -- how does that acquisition performs so far in your opinion, how the results been and also it’s still early but maybe a little bit of color on how -- I’ll speak bit in particular this quarter please.

Guy Bernstein

I will give you some color on Allstates, when we acquired Allstates; we already knew that some of the project will not continue. Therefore we knew what to expect I think we -- in a way we suffered a bit from the slowdown of the telecom in the state, I don’t know if you are all aware but AT&T basically stopped all projects because of their direct TV M&A that they wanted to complete. So, we felt that as well if you ask me like at the beginning of the year I thought we would be way over the expectations. Today, I think we are in a good place but there is a lot to expect in the future because I think we are -- there is a lot to do there. Other than that our profitables are okay and I think they manage that AT&T will be back in the market, you will see it immediately in the business.

Operator

The next question from Kevin Dede of H.C. Wainwright, please go ahead.

Kevin Dede - H.C. Wainwright

Good morning guys, its Kevin Dede. I guess the first question is just on housekeeping Asaf, could you help me understand how the non-comp stock charges broke down within operating cost. I know there were 109,000 I was just wondering how it’s between R&D and SG&A?

Asaf Berenstin

You can go to our press release, you will see a reconciliation of our GAAP and non-GAAP results and we break down the different elements of the non-GAAP adjustments that we insert to our financial statements that broke it up between the gross margin and operating margin. So, I think the picture from this report is pretty clear.

Note basically just to say there is almost no impact to our P&L between our amortization of capitalized software and capitalization of R&D, most of the impact to our P&L which is roughly around close to $900,000, 846 something like that is from amortization of customer relations from previous acquisition.

Kevin Dede - H.C. Wainwright

Okay, fair enough. Then gross margin at this level is it fair to assume that that's what we should expect going forward for the second half of the year Asaf?

Asaf Berenstin

Come again.

Kevin Dede - H.C. Wainwright

Your gross margin at 41.2% on non-GAAP basis for the second quarter is that a fair assumption for the balance of the year?

Asaf Berenstin

Yes, yes.

Guy Bernstein

I think it depends on the mix, usually going towards the second half usually you’ll see more of a software sales, therefore it should improve a bit.

Kevin Dede - H.C. Wainwright

Improve a little bit?

Asaf Berenstin

Yes.

Guy Bernstein

Yes, but it’s enough that AT&T is back to business and you will see a lot on the professional services side but again it all goes to the mixture of the business.

Asaf Berenstin

But again this is probably the raise that you will see; it could be 2% higher than that 1% lower than that but these are the averages.

Kevin Dede - H.C. Wainwright

Right, okay. Guy, you made an interesting point as Microsoft pushing hard for the cloud and that’s necessiting a change, sequentially in the business model and I’m just wondering if you could elaborate on that and give us a feeling for how you’re trying to position Magic Software just and potentially help some of your clients address this change?

Guy Bernstein

So for some of our clients, they are already going there the kind of more the brave ones are already going there some of them are quite conservative and we’re trying to push them, not that easy. On the enterprise level, what we see is more and more enterprises that are taking from some of the applications they have and put it on a private cloud in order to try and fill this cloud thing but still are very cautious but all in all you’ll see the movement, you’ll see that people are talking about it, people are asking about it, people are asking for more proposals to go there, seems that when we enter the cloud world like three years ago, in some markets we saw a lot of interest but in some of them there was none, today I think because the big ones, the giants are pushing towards the clouds you see more and more interest around it.

Kevin Dede - H.C. Wainwright

So give us an indication on how SAP and sales force are addressing the cloud and how they’re dealing with integration issues at that level and a competitive feeling that you might run into given is that their solutions can push down on the mid-tier.

Guy Bernstein

So talking about sales force, they are the first one to market with the public cloud, in terms of the integration that currently they do not offer their own integration platform but we definitely see some other players in the space such as [indiscernible] and other local players. When we talk about SAP they go with [indiscernible] and they’re pushing it. I think it's for SAP more complicated to penetrating space but at the end they will be there because they’re quite strong.

So all in all you see all of them you see the trend and you see that even these people do not close businesses based of the cloud today they definitely want to see that you have the solution if they decide in the next year or two to go there that you can support them with a good solution.

Kevin Dede - H.C. Wainwright

Okay. I’m kind of curious on how you seen, I mean if you can look at it just from geographic regions how you seen changes in political environment globally affect companies and their strategic view and I guess more appropriately their spending patterns.

Guy Bernstein

I’m not sure I understood the question.

Kevin Dede - H.C. Wainwright

Yes, I guess what I’m wondering is in Western Europe or eastern and the confrontations in Eastern Europe and whether or not you think there is an effect there and then also, [indiscernible] you as really basis in the [indiscernible] conflict whether or not you think there could be more of an issue there.

Guy Bernstein

Okay. So let me-- I'll give a general answer to that, Magic is quite spread in terms of the places it has business therefore as we know and then we feel some kind of slowdown in one territory or the other. So in 2009 we started from the Spain, in 2011 we started from Europe at some point we started from the far east mainly Japan but all in all you can see that the units are and the territories are compensating for each other, you know that even if one is a bit suffering, usually the others are a bit stronger, so all in all I think we have a good hedging in this business.

Kevin Dede - H.C. Wainwright

Okay. Fair enough. Can you give us a view on the outlook; did you think there is concern with regard to investment?

Guy Bernstein

We don’t really feel it, in the state we feel that the business is good and including in Europe I cannot say that it is -- that we see an improvement trend but in the space we work we have good visibility on the business, in Japan it looks like business is quite good for us, that's basically it. I think in all the other small places it’s not -- even if the business is good or not good it’s not that significant for us.

Operator

The next question is a follow up from [indiscernible]. Please go ahead.

Unidentified Analyst

Hey guys. I know you didn’t give expense guidance for the year but you sort of indicated that gross margin, acquisitions could improve slightly, when you look at that and you look at the spend on sales and marketing that’s been quite reasonable, do you think that’s accept -- as you make the investments, continue investments Guy to drive growth in the various regions?

Guy Bernstein

I think in terms of percentages wise I don’t think we’ll be lower than that. Meaning, we do want to invest more in sales but usually when we take on board a new sales guy, we -- it comes with the accounts and usually starts to generate business quite fast. So all in all I don’t think you will feel it in the numbers although we do make investments.

Unidentified Analyst

Okay, and then on the margin on pricing, just any color you’ve seen in pricing trends both on the software side as well as the services side.

Guy Bernstein

I think in all the markets we feel a constant pressure on prices. I can say that, you feel it everywhere but you see more business. So, it’s compensate for each other. On one hand you see a lot of pressure; on the other hand you feel way more business.

Operator

(Operator Instructions) There are no further questions at this time. Mr. Bernstein, would you like to begin your concluding statements?

Guy Bernstein

Yes, thank you very much for joining our call and I hope that we will continue this way and give you good results for the next quarter as well. Thank you.

Operator

Thank you. This concludes the Magic Software Enterprises Ltd. second quarter 2014 results conference call. Thank you for your participation, you may go ahead and disconnect.

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