Magic Software Enterprises Ltd. (MGIC) CEO Guy Bernstein on Q4 2019 Results - Earnings Call Transcript

Magic Software Enterprises Ltd. (NASDAQ:MGIC) Q4 2019 Results Earnings Conference Call March 9, 2020 11:00 AM ET

Company Participants

Guy Bernstein - CEO

Asaf Berenstin - CFO

Yuval Lavi - VP of Technology and Innovation

Conference Call Participants

Tavy Rosner - Barclays

Ted Starck-King - William Blair

Operator

Welcome to Magic Software Enterprises 2019 Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation [Operator instructions]. As a reminder, this call is being recorded.

With us on line today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's VP of Technology and Innovation, Mr. Yuval Lavi. Magic quarterly earnings release was issued before the market opened this morning, and it has been posted on the company's Web site at www.magicsoftware.com.

Before we begin, 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 views or expectations, or otherwise.

Also during the course of today's call, management 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 will now turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

Asaf Berenstin

Thank you, Elana. And thank you everyone for joining us today as we report our fourth quarter of 2019 financial results. We entered the second half of 2019 with a firm pipeline of business, which we expect will favor continued strong momentum into the year end. Our fourth quarter and our second half results demonstrated the continued solid execution of our 2019 priorities of top line growth, while maintaining our operating margins for the year.

Sales growth came mainly from the expansion of our business in North America and in Israel, as well as in the Japanese markets. As we said in the past, our business is 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 as organizations continue to migrate from legacy system to more than flexible on premise or cloud based solution, as well as the need for making customers’ expectations for digital and more personalized experience.

Overall during 2019, we signed over 300 new logos across all our products offerings and territories, one third related to our software solutions and the remaining to our professional services. Also in 2019, we took the necessary step that would allow us to increase our leverage by driving more capacity to our offshore entities. These steps allowed us to maintain the gross margins for the year at 33%.

On the M&A front, Magic has demonstrated a solid track record of acquisition 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 offerings for our customers and increased our global footprint.

Our recent acquisition completed during the third quarter of NetEffects, U. S. based company, which specializes in IT staffing and recruiting expanded our footprint in the U. S. market and diversified our client portfolio. NetEffects’ team and its solid customer base that includes several our blue chip companies will help Magic fulfill its commitment to its clients to serve as the one stop shop for the full set of solutions and continue its expansion. We continue with our efforts to find potential companies that fit our strategy and our valuation range. We continue looking for small to midsize companies with revenues in the range of $20 million to $50 million, which will follow our strategy, geographic expansion, complementary products and customer base.

Turning now to our fourth quarter and annual business performance, I will now review our non-GAAP results, followed by comments on the balance sheet, cash flow and end with our outlook for 2020. Our fourth quarter revenue totaled $19.9 million compared to $72.3 million for the fourth quarter last year and $85.8 million in the previous quarter, reflecting 26% and 6% growth effectively.

Looking at the geographical breakdown of our revenues during the fourth quarter, North America accounted for 48% of total revenue, Israel 38%, Europe 8% and APAC and the rest of the world accounted for 6% of our annual revenues. Most of our growth in 2019 in absolute numbers was traditionally for the North America and Israel, which continued to be our strongest territories. North America accounted for 47% of our growth for the 12 months and 55% in the fourth quarter and Israel accounted for 47% of our growth for the 12 months and 40% in the fourth quarter. Our revenues in North America for the 12 months period grew 15% year-over-year and our revenues in Israel for the 12 month period grew 20% year-over-year.

Turning now to profitability, our non-GAAP gross profit for the fourth quarter of 2019 was $29.4 million, up approximately 25% compared to $23.4 million in the fourth quarter of last year. Our non-GAAP gross margins for the fourth quarter of 2019 remained flat at 32.3% compared to the fourth quarter of last year. Our non-GAAP gross margin for the 12 month period of 2019 remained stable at 33.1% compared to 33.2% in the same period last year.

The breakdown over our revenue mix for the 12 month 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 and 72% related to our professional services in 2018 as a whole. The decrease in the percentage of software solutions is due to that acquisition of NetEffects and the expansion of our professional services portfolio, the breakdown on the gross profit mix for the 12 month period of 2019 was approximately 50% related to our software solution and 50% related to our professional services compared to 56% related to our software and 44% related to our professional services in 2018 as a whole.

Moving to operational costs. R&D expenses on a non-GAAP basis in the fourth quarter of 2019 totaled $2.9 million compared to $2.3 million in the same quarter of last year, and $3 million in the previous quarter. The increase in our R&D expenses related mainly to the first time consolidation of PowWow. Furthermore, as evidenced in many other software development companies in the recent year, Magic has also the moving into development efforts to India and opened a 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 support our future growth.

Our non-GAAP operating income for the fourth quarter increased 14% to $11.4 million compared to $10 million in the same period last year. This reflects an operating margin of 12.6% for this quarter compared to 13.9% in the fourth quarter of 2018 and 13.7% in the third quarter of 2019. The reason for the decline in gross margin in the fourth quarter versus previous quarter and the respective quarter is mainly resulting from the holiday of the Jewish month of Shavuot, which this year have entirely coincident with the fourth quarter as opposed to being entirely coincident with the third quarter of 2019. The impact of the Jewish holiday reduced the available working days by 12% versus the respective quarter and by 10% versus the third quarter of 2019.

Our non-GAAP operating income for the year increased 11.2% to [$43.9] million compared to $39.5 million in the same period last year. This reflects an operating margin of 13.5% for the year compared to 13.9% for 2018. Our non-GAAP tax expenses this quarter totaled $2.9 million compared to a tax expense of $2.1 million in the fourth quarter of 2018. Our effective tax rate for the 12 month period of 2018 was approximately 19%. We expect our tax rate in 2020 to be in the range of 20% to 21%.

Our non-GAAP net income for the fourth quarter increased 10% to $6.4 million or $0.13 per fully diluted share compared to $5.8 million or $0.12 per fully diluted share in the same period last year. Our non-GAAP net income for the year increased 9.5% to $28.2 million or $0.58 per fully diluted share compared to $25.7 million or $0.55 per fully diluted share in 2018. Earnings per share for the year were negatively impacted by $0.04 per fully diluted compared to 2018 as a consequence of the company's private placement of 4.3 million shares in the third quarter of 2018 to Israel institutional investors.

Turning now to the balance sheet. As of December 31, 2019, cash and cash equivalents, short and long-term bank deposit and marketed securities, amounted to approximately $98 million flat compared to the previous quarter. Our total financial debt as of December 31, 2019 amounted to $23 million compared to $28 million in the previous quarter. From a cash flow perspective, we generated $13.3 million from operating activities in the fourth quarter and $45.9 million during the 12 month period of 2019.

During the fourth quarter, we paid principal payments towards our financial institution in the amount of $6 million. Additional $6 million were paid towards the amount related to acquisition. Of which, $4.3 million for the acquisition of minority interest in one of our U. S. subsidiaries as part of our strategy to increase our share interest in our subsidiaries, and $1 million of deferred payment paid towards the acquisition of NetEffects acquired during the third quarter of 2019.

I would like to turn now to our guidance for 2020. In 2020, we anticipate revenue in the range between $360 million to $370 million, reflecting annual growth of 10.6% to 13.6%. Such guidance may be affected by the potential impact of the coronavirus on the company and its customers. Additionally, we don't identify any material impact on our business from the coronavirus, but we believe that this is still an early stage to determine the potential impact of this virus on either us or on our customers’ businesses.

As to our dividend policy, we know that it states that in each year the company will distribute the dividend of up to 75% of its distributable profits, subject to discretion of our Board of Directors to change such percentage or decide not to distribute the dividend. In determining the dividend to be distributed for the second half of 2019, which we expect to announce after publishing our annual audited financial statement towards the end of April 2020, our Board of Directors will take into consideration, among other things, the current and potential effect of the coronavirus on the global economy, in general, and specifically on our operation and the company's financial needs in light of such effects.

In summary, this was a strong and exceptional year of execution on many fronts, and we want to congratulate the Magic global team for their outstand work in 2019. The results we delivered show that our strategy is working and that by focusing on investment to deliver profitable growth, we can significantly enhance shareholder value. We remain focused on maintaining our competitive position as a one stop shop for digital transformation with enhanced services supported by proprietary software solution.

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

Question-and-Answer Session

Operator

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.

Tavy Rosner

I was wondering if we could start a little bit with your guidance. So, you talked about the top line growth. I was wondering if you can give some color on the margin side, when you take into account the mix and also your efforts on the outsourcing side. Where does that leave us, let's say, 12-months from now when you look at the big picture?

Asaf Berenstin

I think that if we start on the margin side, basically we can see that in 2018 as in 2019, our margins were pretty flat 33%, and this is despite the increase that we experienced in salaries for employees and the investments that the company needs to do and in its ideas we experienced in 2019 and this is also with respect to the operating margin. So, on the margin side, I think that 33% is a baseline for how we see 2020. And as you know the issue with the coronavirus as you know can move that either way, it's still early for us to know. But on an ongoing regular business here 33% is how we see in the current level today.

Tavy Rosner

And then speaking about the coronavirus, I mean, obviously you can't -- there are many things that you can't predict, especially your customer, but I'm thinking about what you can control. Are there any disruptions, especially in your offshore centers where workers can't go to work or anything that can just help us understand how you guys can mitigate the risk internally?

Guy Bernstein

As far as the technology people, we make sure that all of our key and most of the employees of R&D will be able to work from home that means people that do not have laptops today we're looking how to equip them with laptops, people that might have a bad Internet connection in their territory where they live again, if you know see in India in the Pune area, we’re making sure this to see how we resolve, this is something that we're going to do in the next week or so to make sure that anybody can connect outside of the company and continue working. And we're going to have quick session with all the employees regarding how to utilize to the best Web meetings and the online meetings and other tools to actually be effective as possible to continue having internal meeting as the same with customers using all the technology that is available for us.

Operator

The next question is from Maggie Nolan of William Blair. Please go ahead.

Ted Starck-King

This is Ted on for Maggie. So looks like you guys posted some nice top line growth in the quarter and for the full year 2019 as well. So, I guess my first question would be, where did you guys see the outperformance versus your expectations in 2019? Thanks.

Guy Bernstein

Basically in Israel we managed to increase our performance. We have long lasting customers that see us for them as a one stop shop for many different aspects of professional services, starting from BI to database support to development services. We also enlarged, as I said during the briefing, the capabilities in St. Petersburg. We also have it today around 200 people in St. Petersburg that support offshore services, and we also managed to increase revenues from customers benefiting to work with offshore R&D specialists other than local developer and the same…

Yuval Lavi

And we had very good year last year in the Japan, in the territory of Japan with our big community there.

Ted Starck-King

And then switching over to guidance here, could you remind us what was the organic growth in the quarter and how much is contemplated in your full year guidance for 2020?

Guy Bernstein

Basically in 2019, approximately 60% of our growth came from acquisition and 60% came from strength from organic activity. Since we acquired NetEffects at the mid year of 2019 then based on the guidance that we provided between 33% and 45% of our revenues, it will be at the lower end or the higher end will be from M&A and the rest from organic growth.

Ted Starck-King

So that’s 33% to 45% of your growth from M&A in 2020. Is that correct?

Guy Bernstein

Yes.

Ted Starck-King

And could you walk us through and run us through your guidance methodology, how much visibility do you have to your initial revenue guidance for 2020?

Guy Bernstein

On a normal case and again, putting aside the impact that can be happened from the coronavirus, 80% of our business is pretty much laid out. And we have our software business that generates around $60 million in maintenance and ongoing professional services and additional $30 million in licenses. We don't have any major customer there. This is all based on just customers that are repeating the license acquisitions and the partners that develop software applications and are buying every year for their new account and the existing accounts. And on the PS side, we are working on existing projects. So we have outlined, I would say normally of 80% of our business. And again, before anybody will say for any specific reason that they start the certain project because you know what going on today in the market.

Ted Starck-King

And then last question for me. So could you comment on the health of the CVS relationship, and kind of your expectations for that over the course of the year? Thank you.

Guy Bernstein

Basically, because of our growth and our expansion, CVS was declined from 14% level in 2018 to around 10% in 2019. In terms of the business, we started out in a decline versus 2018. But basically since the end of the second quarter, once they concluded the merger with Aetna, we saw stability in the level of operation that we have with them. And for 2020, we hope to see at least the level of operation that we have today and if not a slight growth.

Operator

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

Guy Bernstein

Thank you everybody that came to the call. We hope that we will be able to deliver a good 2020 as 2019 worked for us. We know what's going on today and we hope to hear from you soon in the next quarterly call.

Operator

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