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Magic Software Enterprises Ltd.

MGIC US

Magic Software Enterprises Ltd.United States Composite

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Q4 2016 · Earnings Call Transcript

Feb 21, 2017

Executives

Guy Bernstein - Chief Executive Officer Asaf Berenstin - Chief Financial Officer Itai Galmor - VP, Global Marketing and Business Development Amit Birk - VP, M&A and General Counsel

Analysts

Maggie Nolan - William Blair Tavy Rosner - Barclays

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Magic Software Enterprises Ltd.

2016 Fourth Quarter Financial Results Conference Call. With us on line today, are Mr.

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

Itai Galmor, VP, Global Marketing and Business Development; and Mr. Amit Birk, VP, M&A and General Counsel.

I will now turn the conference 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 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 obligations to update or revise any of these forward-looking statements whether because of future events, new information and change in its view or expectations or otherwise. Also, during the course of today's call we will refer to certain non-GAAP financial measures.

A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press release issued before the market opened this morning. A replay of this call will be available before the call on the Investor Relations section of the Company's Web site.

I will now turn the call over to Guy.

Guy Bernstein

Thank you, Amit. Good morning, everyone and thank you for joining us today as we report our fourth quarter and full year 2016 financial results.

During this call we will review the highlights from our fourth quarter and full year results and then turn it over to Asaf who will provide more detailed financial information. I will be happy to address any of your questions at the end.

We are pleased that we exceeded our full year revenue guidance delivering record breaking revenues for the year of $202 million which reflects 15% year-over-year growth. We are also pleased with our operating cash flow which grew by 43% year-over-year to $28.1 million for the year.

We were aware that our margin were going to be affected this year due to the software licensing renewal lifecycle, which meant that some of our large enterprise customers running mission critical applications are only due to renew their software agreement licenses starting next year. I am pleased that we were able to compensate for this.

Magic had a very busy year with the acquisition of Roshtov, different product releases, significant customer announcements for enterprise mobility and digital transformation solutions, as well as a number of partner certifications, awards and new initiatives. We believe all of this along with our high visibility to the business, our diverse portfolio and the upturn in the software license renewal life cycle make us very positive about our ability to accelerate growth and ramp up operating profit in 2017.

Now I would like to turn the call over to Asaf, our CFO, to discuss the financial results in more detail. Asaf?

Asaf Berenstin

Thank you, Guy, and good morning, everyone. Before I jump into our results I would like to remind you that we are presenting our results on a non-GAAP basis, which as mentioned at the beginning of the call, gives a clear view into our operational state of business and provides valuable supplemental information regarding our results of operation.

There is a detailed reconciliation to non-GAAP results in the financial tables of the earnings press release. Our fourth quarter revenue was $55.5 million compared to $47.9 million for the fourth quarter last year, reflecting 15% year-over-year growth.

Looking at the geographical breakdown of our revenues, we maintained a diverse geographic mix. For the fourth quarter, our revenues in North America represented 48% of total revenues, Europe including Israel, showed the strongest regional growth this quarter due to our strong momentum in the Israeli market and the addition of Roshtov to our portfolio represented 43%, and APAC and the rest of the world represented 9% of overall revenues.

Turning now to profitability. Our non-GAAP gross profit for the fourth quarter was $19.3 million, up 3% compared to $18.8 million in the fourth quarter of last year.

Our non-GAAP gross margin was 35.1%, down from 39% from the fourth quarter of last year and 37% in the previous quarter. The decrease in our gross margin resulted mainly from the shift in our revenue mix from software towards professional services and the software renewal lifecycle amongst some of our larger enterprise customers which were not due for renewal this year.

The breakdown of our revenue mix over the fourth quarter was 35% software and 65% professional services versus 38% software and 62% services in 2016. R&D expenses on a non-GAAP basis in the fourth quarter totaled $2.7 million compared to $2.2 million in the same quarter last year.

Our non-GAAP operating income for the fourth quarter decreased 1% to $7.3 million compared to $7.4 million in the same period last year. This reflects operating margin of 13.2% for the quarter compared to 15.4% for the fourth quarter last year and 14.2% in the previous quarter.

The weakness in our operating margin resulted mainly from software renewal lifecycle amongst some of our larger enterprise customers which as I mentioned earlier, are only due for renewal starting next year. Our non-GAAP tax expenses this quarter were $1.6 million, representing an effective tax rate of 22% compared to tax expenses of $1.3 million in the fourth quarter of 2015, reflecting an effective tax rate of 18%.

We believe that our effective tax rate for the full year of 2017 will range between 20% and 21%. Our non-GAAP net income for the fourth quarter decreased 24% to $4.3 million or $0.10 per fully diluted share, compared to $5.6 million or $0.13 per fully diluted share in the same period last year.

The decrease in our net income is mainly due to an increase in our tax expenses and in our net income attributed to non-controlling interest amounting to $1.1 million or 2.5 cents per fully diluted share. Turning to the results for the year.

Revenues for the full year increased 15% to $201.6 million above our guidance and compared to $176 million in 2015. Our non-GAAP gross profit were $73.6 million compared to non-GAAP gross profit of $68.3 million in 2015.

Non-GAAP gross margin for the year was 35.5% compared to 38.8% in 2015. Just like in the quarterly results, the decrease in our gross margin resulted mainly from the shifting in our revenue mix from software towards professional services and from the software renewal lifecycle among some of our larger enterprises which were not due for renewal this year.

Our non-GAAP operating income for the year was $28.2 million or 13% operating margin, up 4% compared to non-GAAP operating income of $27.2 million or 15.4% operating margin in 2015. Our non-GAAP net income for the year was $19.6 million or $0.44 per diluted share compared to non-GAAP net income of $21.7 million or $0.49 per fully diluted share last year.

The decrease in our net income is mainly due to an interest in our tax expenses and in our net income attributed to non-controlling interest amounting to $3.6 million or $0.08 per fully diluted share. Turning now to the balance sheet.

We ended the year with approximately $77.8 million in cash and cash equivalents, short-term bank deposits and marketable securities compared to approximately $77 million as of December 31, 2015. The increase in our total cash balance is mainly due to our strong cash flow from operating activities amounting to $28 million for the year and from $31.5 million loan obtained to support our growth, offset by the payment of approximately $32 million mainly towards the acquisition of Roshtov and $7.8 million in dividends paid to shareholders since the beginning of the year which reflects an annual dividend yield of 2.5%.

Turning to our 2017 guidance. We expect 2017 full year revenue to be in the range of $225 million to $230 million, reflecting an annual growth rate between 12% to 14%.

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

Guy Bernstein

Thank you, Asaf. We are pleased to have produced our seventh straight year of record revenue and to have exceeded our revenue guidance with revenues of $202 million despite some challenges.

We have worked hard during 2016 and believe that all these efforts will have a small effect picking up [steam] [ph] during 2017. In addition, the high visibility we have into the business along with our diversified portfolio and the upturn in software license renewal lifecycle make us very positive and optimistic about our ability to accelerate growth and ramp up operating profit in 2017.

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

Operator

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

Maggie Nolan

This is Maggie Nolan in for Bhavan. You talked a little bit about gross margins being down.

Can you give a little more color and why they were down? And also, do you expect margins longer term to be in this new range or based on where margins are now, does that change your longer term expectations for gross margins at all?

Guy Bernstein

Okay. So we mentioned during the call that we had this, basically we have this lifecycle of renewal of these agreements, technology agreements with some of our biggest enterprises.

Unfortunately, this year we didn’t have that much renewals and we expect starting next year to have better results in terms of the technology sales as a result of that. So this should improve the gross margins.

Other than that, I think it all goes to the mixture between software sales and services so if we keep the same level of sales between software and services then I believe that margins should go up to the same level they were last year.

Maggie Nolan

Okay, great. Thanks.

And then from a segment perspective, was there any churn in your banking and insurance segment and then how much visibility do you have and do you expect customers in that segment to be renewing as well?

Asaf Berenstin

Over the last six-seven years we only had one client that stopped using the software following the fact that it was acquired by another entity and therefore they changed their use of application. Other than that we never had a situation where those customers that we mention, the large ones, didn’t renew their license.

We are speaking about companies that are using their software for mission critical platform. So there wasn’t any case that they didn’t renew their licenses.

Guy Bernstein

A vast majority of them are banks and insurance companies.

Maggie Nolan

Okay, great, thanks. And last one from me.

Can you talk a little bit about demand in the quarter across your integration business and how mobile and cloud is progressing? Thanks.

Guy Bernstein

Basically, we keep on seeing strong demand towards our mobile and integration projects. This year we had some significant projects for multi-million dollar worth of spending from the customers' side.

So we see a pickup. It's still not something that is significant towards the $202 million total revenue but this is something that adds up.

In addition, the integration is always complementary to the mobile. When the customer wants to develop a mobile application, they usually need to connect it back to their backhaul systems and this also brings us new integration projects.

Itai Galmor

This is Itai. I would like to add that our momentum on mobility and cloud is backed up by industry analysts that have started covering us in the mobility enterprise and [indiscernible].

And integration platforms we have been covered with Gartner and Forrester in the coming years. So I think we have got a very positive momentum and I think it will probably have a good effect on our business of 2017 and '18.

Operator

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

Tavy Rosner

Just a follow up with regards to the renewal of the licensing part. Do you have a sense of why so many of this customer didn't renew in '16 and will do so in '17.

Was there anything specific that kind of pushed their decision away by a few months?

Guy Bernstein

Hi, Tavy. It's not about pushing their decisions.

It's about the way it was planned from the beginning because usually what happens is most of them have agreements between three to five years. And after the end of the three to five years, they need to renew it.

So apparently this year the number of renewals that we had when we started the year was quite low compared to previous year. So it has nothing to do with customers postponing their renewals.

It's more about -- it's a technical thing that when we planned it we knew that we are going to take this. Luckily enough, we were able to compensate for all of that from other places because next year we already know what we have to renew for.

We already know the list and the year is going to be much better.

Tavy Rosner

Right. So it's more timing decisions, therefore next year you should probably anticipate to have a stronger leaning towards...?

Guy Bernstein

It's a pure timing issue.

Tavy Rosner

Right. So the mix over software will be stronger in '17 most likely?

Guy Bernstein

Yes.

Itai Galmor

Tavy, it's pure backlog. For this time in 2017, at this time it's pure backlog.

Tavy Rosner

So logically the mix will be stronger in '17 than in '16 and your margins will reflect that?

Itai Galmor

Exactly.

Guy Bernstein

Probably in 2021 we will have the same issue of renewal.

Tavy Rosner

Okay. Good to know.

And just a last one on the M&A side. So you did a few acquisitions last few quarters but you still have positive net cash balance.

Do you guys still see a pipeline of acquisition on your radar?

Guy Bernstein

Yes. I must say that we have two or three at the moment that some of them are early stage, one of them is maybe a bit more progressed.

But still an attractive [indiscernible] and at the end we look for a good acquisition for a decent price. And most of the things that we see in the market right now are quite overpriced.

It's a struggle but I believe by the mid next year we will probably close at least on the small ones. The bigger ones that we have currently, one of them we can close.

I am not sure we want to close with the current prices, so we will see.

Operator

There are no further questions at this time. Mr.

Bernstein, would you like to make your concluding statement?

Guy Bernstein

Thank you very much everyone for joining us and we hope to come with good news in the next quarter. Thank you.

Operator

Thank you. This concludes the Magic Software Enterprises Ltd.

Fourth quarter 2016 results conference call. Thank you for your participation.

You may go ahead and disconnect.

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