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Magic Software Enterprises Ltd.

MGIC US

Magic Software Enterprises Ltd.United States Composite

10.61

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Q3 2014 · Earnings Call Transcript

Nov 10, 2014

Executives

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

Analysts

Bhavan Suri – William Blair Tavy Rosner – Barclays Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Magic Software Enterprises Limited’s Third Quarter 2014 Results Conference Call.

All participants are currently in a listen-only mode. Following management’s presentation, instructions will be given for the question-and-answer session.

(Operator Instructions) I’d also like to remind you that this call is being recorded. With us on the line today are Mr.

Guy Bernstein, CEO; Mr. Asaf Berenstein, CFO.

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 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, a change in its view or expectations or otherwise. On this call today, management will provide you with details about Magic’s performance in the third quarter and first nine months of 2014, including certain non-GAAP financial measures.

The company provides non-GAAP financial measures because they believe that they are the most valuable ways to review its core operating results. The company provided a reconciliation of non-GAAP measures to their comparable GAAP measures in its earnings release, which was issued before the market open this morning, and has been posted on the company’s website at www.magicsoftware.com.

A replay of this call will be available after the call on the Investor Relations section of the company’s website. Now I will now turn the call over to Mr.

Guy Bernstein, CEO of Magic Software. Mr.

Bernstein, please go ahead.

Guy Bernstein

Good morning and thank you everyone for joining us today as we report our third quarter 2014 financial results. I will review the highlights from the third quarter discuss our focus going forward and then turn it over to Asaf, who will dig deeper into the numbers.

We are pleased with our strong performance for the third quarter and first nine months of 2014. With record earnings and non-GAAP operating income for the first nine month period, we continue to show steady growth in both our top and bottom line as a result of our diverse in-demand portfolio of products and services, our growth strategy and our operational discipline.

Revenues in the third quarter reached $40.2 million, an increase of 13% year-over-year with non-GAAP operating income of $6.4 million reflecting an increase of 8% over the prior year. We continue to experience positive sales momentum for our software and professional services offerings and are seeing great interest in the recent enhancements to our enterprise mobility, integration and services offerings.

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

Asaf Berenstein

Thank you, Guy. Today we will be analyzing our results on a non-GAAP basis, which as mentioned at the beginning of the call better conveys the operational state of the business.

The financial table provided in our third quarter earnings press release included detailed reconciliation of non-GAAP measures to the comparable GAAP measures. As Guy mentioned, our first quarter revenue was $40.2 million up 13% compared to $35.6 million for the third quarter last year and down 1% compared to $40.6 million for the second quarter of 2014.

As we derived approximately 38% of our revenues from Europe and Israel, our revenues for the third quarter were negatively impacted by $400,000 due the devaluation of the average rate of the euro and new Israeli Shekel decreasing 3.5% and 1.5% respectively versus the dollar compared to the second quarter of 2014. Our non-GAAP gross profit was $16.3 million up 2% compared to non-GAAP gross profit of $16 million in the third quarter of last year.

Non-GAAP gross margin was 40.5%, reflecting a decrease of 70 basis points compared to 41.2% recorded in the second quarter of 2014. Our non-GAAP operating income for the third quarter of 2014 was $6.4 million or 16% operating margin, up 8% compared to non-GAAP operating income of $6 million or 17% operating margin in the third quarter last year and up 7% compared to $6 million or 14.8% operating margin in the second quarter of 2014.

Our GAAP net income for the quarter was $4.2 million or $0.10 per diluted share, based on 44.5 million fully diluted shares outstanding compared to GAAP net income of $4.2 million or $0.11 per diluted based on 37.4 million fully diluted shares outstanding. I would just like to remind you that the slight decrease in EPS is due to our share count increasing as a result of our $59 million public offering this past week [ph].

Our non-GAAP net income was $5 million or $0.11 per diluted share, compared to non-GAAP net income of $5.5 million or $0.10 per diluted share in the third quarter last year. Our non-GAAP net income for the quarter was negatively impacted by devaluation of cash balances denominated in euros and new Israeli Shekel, following devaluation of the foreign currencies versus the U.S.

dollar. Turning to the balance sheet, we ended the quarter with $85 million in total cash and short-term investments.

Our strong financial position 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 form a dividend.

During this quarter we distributed a dividend for the first-half of 2014 of $4.2 million or $0.095 per share in accordance with our dividend policy. From the beginning of the year we have distributed $8.7 million or $0.215 per share.

Our current dividend yield is approximately 2.7%. With that, I will turn the call back to Guy for closing comments.

Guy Bernstein

Thank you, Asaf. In summary, we had another good and profitable quarter.

Our revenue for the trailing 12 months amount to $163 million, and as announced in the first quarter we expect full-year 2014 revenues of approximately $161 million to $165 million and are currently on-target to meet this goal. With that I will now turn the call over to the operator for questions.

Operator

Thank you. (Operator Instructions) The first question is from Bhavan Suri of William Blair.

Please go ahead.

Bhavan Suri – William Blair

Hey, guys. Can you hear me okay?

Guy Bernstein

Yes, hi, Bhavan.

Bhavan Suri – William Blair

Thanks. Thanks for taking my question.

I guess, the first one I want to quickly touch on is gross margins tick down and could you just give a little color on why that was and what the currency impact might have been to that. And then just a – as we go down the P&L there, what the currency impact would have been on EPS, so if it was a $0.11 what that would have been without the – in constant currency?

Guy Bernstein

Talking about the gross margin, I think the main impact was not due to the currency value, due to the vacations. So because some – big chunk of the business is based on services due to the – because of the vacations August, and the holidays in Israel, it went down just a bit.

I think it’s completely insignificant. And you will see the increase in Q4 back to a better number.

Bhavan Suri – William Blair

Great. And then just, Guy, on the EPS line, again that definitely was impacted by currency sort of – what would the $0.11 have been in constant currency?

Asaf Berenstein

There was practically no impact. Again you need to understand that perhaps on the top-line we may be exposed to devaluation in the foreign currencies, but we have – first of all we have four transactions that we do in order to hedge our activity on one hand and second by then we also have a natural hedges coming from different sides of our activities.

So there was no actual, or let’s say, meaningful impact on the bottom line.

Guy Bernstein

Not on the operating level, by the way we did…

Bhavan Suri – William Blair

No, no, not on the operating line, on EPS, where you said there was negative impact of the cash balances. I’m just trying to figure out what that negative impact was in terms of an absolute number.

Asaf Berenstein

$0.5 million.

Bhavan Suri – William Blair

Okay. Perfect, that’s helpful.

And then just turning to the business, you were talking earlier or even last quarter, about some of the momentum you’re seeing as people started looking at hybrid clouds, Guy, maybe you can provide a little more color about recent customers and the traction you’re seeing in that space because it continues and what is the pipeline around the software deals both for the integration platform and xpa look like?

Guy Bernstein

I think in all our offerings we see an increase in demand. Although we didn’t see it in Q3 we definitely see it when we start Q4.

Let’s not forget one thing, when we started the year, we expected – we gave this guidance to the market while we thought we will be – it will be quite easy for us. Unfortunately, we suffered a bit from the merger between AT&T and DIRECTV.

And they basically blocked most of the projects. So we have to overcome like $8 million, $9 million in terms of revenues from other customers.

And we did it quite nicely, I think. What we see now, we see that they’re starting to give us more and more projects and all-in-all it should be, it should look – the way we see it, it should look much better next year.

But even for Q4 we definitely see some good signs in terms of the demand, in terms of the revenues and in terms of the profitability.

Bhavan Suri – William Blair

Great, great. And then, I know you’ve been making some sales investments again systematically, not sort of just throwing it against the wall there.

Any update on how those are going, and then as you look at next year and you look at sort of your sales headcount today, sort of any sense on how you plan to increase that?

Guy Bernstein

Yes, we definitely look all the time to increase our sales force. We start, it will be easier to find good sales people, unfortunately it’s not – we are a bit behind in terms of hiring more sales people.

But, definitely this is intention, because we see more and more projects. The problem is that usually when you take sales guy it takes him like at least six months until he’s productive.

And I can say that from our experience, I would say probably between 30% to 50% success with the recruitment.

Bhavan Suri – William Blair

And two follow-ups, that one is, so did I hear you correctly that AT&T and DIRECTV, which had passed are now starting to open up projects?

Guy Bernstein

This is what we see now, but by the way as I mentioned before we did overcome this whole thing with other customers.

Bhavan Suri – William Blair

Yes, sure, sure. That’s helpful though.

And then when you look at the sales hires, you cited this in the past to where the sustainability and guys you hire sometimes they don’t last, because they don’t fit or whatever, is there anything you’re doing sort of as you look at the new hires to sort of test if they’ll fit rather than higher them and find out they’re not working six months down the road?

Guy Bernstein

Problem is that, when you interview them based on their CVs and based on the way they talk, they all look really great. The problem is sometimes you hire them, and they start and they don’t fit, in other cases suddenly they get like a better offer, and they leave you immediately.

Some of them are trying and are not good, and some of them they continue with us and doing a good job. But it’s definitely not easy especially in the States and I would say probably in Germany, Japan.

Although in Japan, we are doing quite okay on this one. I would say in the States it’s not easy.

Bhavan Suri – William Blair

Okay, okay. And then just one last one for Asaf.

Stock option comp jumped a little bit, Asaf? It seems to be a little higher than previous period, any sense of why that was?

Asaf Berenstein

Yes. Of course, this was a one-time hit that we took one of the transactions that we purchased in the past.

There was a stock-based compensation that was subject to achieving certain amount of results. The agreement, the grant option was delayed for slight sometime and once it was done, we have to record this expense immediately, so this is something that you won’t see coming back in the quarters to come.

Bhavan Suri – William Blair

Great, thank you. Thanks for taking my questions, guys.

Guy Bernstein

Thank you, Bhavan.

Operator

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

Tavy Rosner – Barclays Capital

Yes, thank you for taking my question. Sorry, I missed the first answer when you talked about gross margins being slightly down this quarter, what was your answer for that?

Guy Bernstein

I said that the main reason is the vacation that we have in Europe during the summer and the holiday that we have in Israel during September and October.

Tavy Rosner – Barclays Capital

So, looking ahead to next quarter, can we expect something in the same range of the first nine months?

Guy Bernstein

You should expect something, which is a bit better.

Tavy Rosner – Barclays Capital

Okay. And moving to the next question last quarter you talked about some M&A potential deals you could be looking at – what’s the situation this quarter?

Guy Bernstein

This quarter we are looking at basically three companies, two of them are in I would say better stages. I think one of them we will probably close in Q4.

The other two, I would say one of them is not – I cannot say that we can close it yet, but the second one I believe we can close it probably somewhere beginning of the year.

Tavy Rosner – Barclays Capital

All right. Thank you for the color.

And I think that’s it for me. Thank you very much.

Guy Bernstein

Thank you.

Operator

(Operator Instructions) There are no further questions at this time. Mr.

Bernstein, would you like to make a concluding statement?

Guy Bernstein

Yes, thank you all for joining our call, and I hope you will be with us for the next call in Q4. And I hope we’ll bring some good news for Q4.

Thank you very much.

Operator

Thank you. This concludes the Magic Software Enterprises Ltd.

Third quarter 2014 results conference call. Thank you for your participation, you may go ahead and disconnect.

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