Guy Bernstein - CEO Asaf Berenstin - CFO

Bhavanmit Suri - William Blair & Company Kevin Dede - H.C. Wainwright & Co.

Good morning, everyone, and thank you for joining us today as we report our fourth quarter and full year 2017 financial results. I'm very pleased with the results of our fourth quarter and the year as a whole, as we continue to experience consistent year-over-year growth and increased level of profits.

We are pleased that we exceeded our full year updated revenue guidance, delivering record-breaking revenues for the year amounting to $258 million, which reflects 28% year-over-year growth consistent with the increase in our non-GAAP operating income of 24% to $35.1 million for the year. The strength of our performance in the quarter and throughout the year was broad-based with all of our regions in the market producing solid organic growth.

Our growth was a direct result of our outstanding technologies together with solid execution of our strategy position in Magic Software as an innovating software solution provider. Both our software and professional services continue to enable our ever-growing customer base to streamline their businesses to achieve digital transformation.

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

Thank you, Guy. Good morning, everyone.

Before I jump into our results, I would like to remind you that we are reporting our results on a non-GAAP basis, which as mentioned at the beginning of the call, gives a clear view into the operation and state of the business and provide value and supplemental information regarding our results of operation. The EBITDA reconciliation to non-GAAP results in the financial data from the earnings press release.

Our fourth quarter revenue totaled $66.1 million compared to $65.1 million for the fourth quarter last year, reflecting 28 year-over-year growth mainly driven by our organic expansion. Looking at the geographical base of our revenues, our geographic mix remained steady throughout the year.

North America accounted for 48% of total revenue like; Israel, 36%; Europe, 10%; and APAC and the rest of world accounted for 6% of our annual revenues. Most of our growth in 2017 as well as in the fourth quarter in absolute numbers were from North America and Israel, which continue to be our strongest territories.

North America accounted for 38% of our growth and Israel for 57%. Analyzing our revenue growth, our organic growth was approximately 64% accounting for 18% of our annual growth rate.

I would like to emphasize that for the four most recent quarters, all of our growth from quarter-to-quarter was organic. Turning now to profitability.

Our non-GAAP gross profit for the fourth quarter of 2017 was $22.4 million, up approximately 16% compared to $19.3 million in the same period last year. Our non-GAAP gross margin was 33.9%, down from 35.1% for the fourth quarter of last year and 34.7% compared to the previous quarter.

The continued decrease in our gross margin compared to the respective quarter resulted mainly from the shift in our revenue mix of software towards Professional Services. The breakdown of our revenue mix for the fourth quarter of 2017 was 30% related to our software solution and 17% related to our professional services versus 35% of solution and 65% Professional Services in 2016 as announced.

Looking at the entire year, our revenue related to software solution amounted to $77.1 million reflecting approximately 9% year-over-year growth and our revenues related to professional services amounted to $180.9 million, reflecting approximately 38 year-over-year growth. Moving to operational cost.

R&D expenses on a non-GAAP basis in the fourth quarter of 2017 totaled $2.6 million compared to $2.7 million in the same quarter last year. Our non-GAAP operating income for the fourth quarter increased 19% to $8.7 million compared to $7.3 million in the same period last year.

This reflects an operating margin of 13.2% for the quarter with the same way in the fourth quarter of 2016. Our annual non-GAAP operating income increased 24% to $35.1 million, compared to $28.2 million in 2016.

This reflects an operating margin of 13.6% compared to 14% in 2016. Our non-GAAP tax expenses in the quarter totaled $1.9 million, representing an effective tax rate of approximately 24% compared to a tax expense of $1.6 million in the fourth quarter of 2016, reflecting an effective tax rate of 23%.

Looking at the year, our non-GAAP tax expense totaled $7.1 million, representing an effective tax rate of approximately 21%, compared to a tax expense of $5.1 million in 2016, reflecting an effective tax rate of 18%. We estimate that our effective tax rate for the full year of 2018 will range between 21% and 22%.

On a non-GAAP net income for the fourth quarter increased 10% to $4.8 million or $0.11 per fully diluted share compared to $4.3 million or $0.10 on a fully diluted share in the same period last year. Turning now to the balance sheet.

We ended the year with approximately $91 million in cash and cash equivalent deposit and marketable securities compared to approximately $88 million on December 31, 2016. Our total financial outlook for December 31, 2017 amounted to $38 million compared to $35 million at the end of 2016.

For the cash flow perspective, we generated $8.7 million from operating activities in the fourth quarter compared to $6.3 million in the same period last year and $26.5 million for the year compared to $28 million in 2016. Today, our Board of Directors declared a cash dividend in the amount of $0.13 per share and in the aggregate amount of approximately $5.8 million for the second half of 2017, reflecting 75% of net income attributable to Magic shareholders.

Together with the dividend distributed for the first half of 2017, we distributed and returned a total of $0.26 per share related to our 2017 earnings and in the aggregate amount of approximately $11.6 million, which reflects the dividend yield of approximately 3.3%. Now returning to our 2018 guidance, we expect 2018 full year revenue to be in the range of $283 million to $293 million on a constant currency basis, reflecting an annual growth rate of 10% to 14%.

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

Thank you, Asaf. So in summary, we are pleased to report that 2017 was Magic Software most successful year ever with the exception of year-over-year revenue growth, strong demand across our entire portfolio and throughout all of our regions.

Our remarkable portfolio continues to provide state-of-the-art services and products to our customers in the area of integration, software application development, more by big data and cloud. As a result, we continue to be recognized throughout the industry for our quality and innovation.

We expect that our strong financial provision, coupled with our 2017 activities in promoting and growing our markets will continue that company's momentum into 2018. With that, I would now turn the call over to the operator for questions.

Nice job there, Guy, congrats. You've had now a few quarters of just really solid growth, and I think Guy, across all the segments, but just to dig a little bit, what is driving toward the outperformance?

Is it the -- obviously software mix is shifting, but sort of what sort of projects driving and maybe what sort of verticals are you seeing the growth come from, especially some of the outperformance in the areas you're probably not expecting?

I think it's quite broad. We see it all over.

We see it around the financial sector, the health care sector. To some extent, maybe even communication, the telecom.

But all in all, it's across the board. I think the vast majority of the project around transformation, whether it's preparation or shifting towards cloud and mobile and the rest of the trend, nothing specific.

I think we see a lot more in terms of volume, is probably a lot more around cloud solutions, rather than mobile, but all in all, a lot of preparations.

Got it. And then if I were to look at some of the custom environment here, you always had sort of software development housing themselves, but this idea of low code sort of with business logic, a little like your software platform, you start to pick up a lot of traction.

I'm just wondering if you're seeing new players in that space at all, because like Appian or others, they're saying we're in developments in that business logic fraction as opposed to generating code. Just wondering how is changing or are you seeing any different players or to enter.

For us, since we are quite based on our own community with the software housing working with us for many years, we see competition over there. Talking to the tech analyst, we definitely hear about all kinds of newcomers to this area starting with marketing product for free in order to catch market share.

But we don't really see them as competition yet.

Got it. Interesting.

And then one other one from me. As you look at the mix for '18, I know you sort of has seen this shift toward more services, but if I look at the mix for '18 and maybe even say 3 or 4 years out, do you think that mix stays stable where it is today?

Do you think special services a little bit more? Or do you think we see software pick up a little farther than the mix?

As you know, we always push for the software because this is the driver for the whole business. But all in all, we do face a situation where we take projects and customers, for some reason, tend to negotiate the technology price and other services so as long as the project make sense, usually, we don't care as long as we make our margins.

So there is a bit of shift over there, but other than that, yes, the focus is first and foremost, on the software side.

I can add to that, currently as we said, it is 70% professional services and 30% on software, then maybe a shift of up to 5% toward the software in Q2.

Asaf, you said that 70 30 split, that was for the full year, right? 2017 full year?

It's the full year, it's also pretty much for the quarter. Yes.

And the quarter, okay. And that was up from 65 35 in 2016?

Last year, yes.

So Asaf, I apologize. But you can speak faster than I can hear.

I missed the numbers that you offer for organic growth and acquired growth for the full year 2017.

I said that the -- for what do you mean? For the revenue?

Yes. I thought it was in your prepared remarks.

You spoke to how much your 2017 growth was driven by acquisitions versus organic.

Yes. So as I said, if we grew 28% year-over-year, 18% came from organic growth and the 10% came from M&A.

[indiscernible], which we basically did last year, and we had for consolidated them this year.

Right. Okay.

So that sort of gets back to the elephant and that would be what the pipeline looks like. I don't know if Amit's on the call, but whatever you guys could speak to in terms of what you're seeing.

Obviously, talked about other companies in the mix and crowding the space, I'm just wondering if you think valuations are still too wacky for you guys to pull the trigger, could still sitting with a pretty big war chest? How does that work now?

I think in terms of the price, we've seen, whatever we talk about technology players, so yes, the prices are still quite high, especially talking about young companies that are coming with nice ideas. Valuations are a bit crazy for us, but having said all that, we're having the pipe like for now, we have one company in the pipe that, I think, is at reasonable multiple.

And we have probably 2 or more companies in the pipe that are more seriously related.

Okay. So Asaf talked to maybe the mix, sort of switching back a little bit to the course of this year.

Can you talk to what your headcount was at the end of 2016? What it was at the end of '17?

And what you think it will be without any acquisitions this year?

Just in terms of personnel?

Yes.

So basically, at the end of last year, we were approximately 2,300 employees and this year, we are, let's say, around 2,500 employees.

Okay. And then how do you think that changes through the course of this year given the mix change that you're expecting?

And that I expect, as we grow, as our professional services grow, we managed to obtain a more talented professional service being in order to facilitate our project. We expect -- as we said, we expect next year to continue with the growth and with that, we need to recruit more people.

Fair enough. Okay, so the 10% to 14% that you're offering as guidance for this year, is that predicated primarily on the customer base that you have now?

Can you tell us a little bit about the sales channel as you see it? And how you expect to add new customers versus the customers that you have and how that might impact your forecast or your guidance?

Okay, I'll relate to that. As you know, the business is built in a way that we say that probably 80% of our -- of 2018 is, we don't call it backlog, but it's repeated business.

Therefore, we have quite good visibility on this business. And then we need to achieve the additional 15% to 20% in order to achieve the growth.

Now on the technology side, we invested heavily into the integration part and we do see some first time on this one. Hopefully, it will grow fast and we'll see more and more partners and customers coming in.

But all in all, you know it's -- in the end, I think we're quite conservative and we have good visibility on where the projects are coming from.

Okay. Now I know the SaaS-based xpc model was a big deal in the last time we talked at the end of the third quarter, I'm wondering if you can sort of give us some insight on how you're seeing your customers react to it?

And I know Asaf talked to the margin change being primarily the sequential margin change, being primarily driven by professional services. I just was hoping you can give us some insight on how your customers are looking at the SaaS model versus the way that they've normally done business with you and what the financial implications are.

As you know, basically, we see that there is a significant shift to reflect in the market to perpetual models to from SaaS models, and this is where the market is going. I think that in terms of Magic, I don't think that most of our revenues are still coming from professional customers and the level of the SaaS is still pretty low and relates to our integration, our integration software.

I don't necessarily see, as I expect the increase that will come from new customers to cover any shift that may happen in the integration field. So in terms of financial, our financial results I don't think that GAAP would have a negative impact to shift between the perpetual and the term license or the SaaS model on our revenues.

Okay, fair enough. Can you just give us a little insight on how your customers are reacting to the introduction?

I know it was a big deal for you guys. I know you put a lot of emphasis on it.

I just haven't spoken to your customers and I just would appreciate hearing some feedback on how they see working with it.

Okay. So when you talk about, when you relate to our customers, most of our customers are still based on the previous versions of the integration platform.

The xpc was launched mainly to attract new customers, not our own customers. The first impression is that it's really not bad, but still small amount.

It's of course, pure soft, monthly subscription and the rest of it. Now, we are about to introduce the new integration platform and then we will see how our customers will respond to that.

Okay, fair enough, Guy. Can you give us some insight on its capabilities?

I mean, clearly, you've got the APIs work across all these other platforms. I'm just curious as to how far you've gotten integrating all those different capabilities into the cloud xpc offering that you have now.

I don't think we should go into the details of the technologies that we provide because this is probably not the place. But all in all, the xpc is a more simple version of the integration, the full robust integration platform because it's a plug-and-play.

It's not for, I'd say, not for big organizations. Big organizations still use the XPi.

And, of course, we follow, even with the new version, they will go on cloud in a different way than the SaaS one. It's different.

Okay. All right, fair enough.

But you said you're working now to introduce a new platform. Is that tailored to address your larger customers or larger customers?

Both our larger customers and new customers as well, large customers. Basically, we are trying to ride on the momentum in the market that we see from the competition.

Okay. What else did I have?

Yes, okay. I think -- well, actually, one last question.

Just on mobile. You mentioned, I think Asaf mentioned that -- or probably you did, you mentioned that mobile maybe hadn't been as strong as you thought it might have been, and I'm wondering if you could just add some color to that.

What do you think is going on there? Why do you suppose there hasn't been as much attention played on -- placed on it by the enterprise customers?

I think there's a lot of attention by the enterprises. I think what we're seeing in many of the projects there, their organizations are planning to go mobile with, I would say, too much information that mobile devices can handle.

And there, that kind of beck you off and go with more simple stuff that you can manage. In many places, you see that they come up with ideas to take like a desktop applications to mobile, but they found out that there are too many -- there are too much information to handle for a mobile device.

So some of them are moving to tablet and some of them are minimizing whatever they need. So a little bit there is some kind of learning here over there.

Do you think that given that it might take them a little bit longer to get their arms around the project, do you still -- do you think that they're going to still continue with the project? Or do you think they're going to shelf them?

Does that just mean that your backlog increases, I guess it's kind of the question.

To be honest, I don't think that is that material and the overall operation that we are focusing, our tax form -- our development platform is clear to provide the solutions. We also provide, by the way, mobile assortment in HTML file in other development, so this is something that we encountered.

I don't think that if you return to backlog, that this is something that we consider a significant or may have any significant impact to our operation.

Yes. So thank you, everyone, for joining us today.

We sure hope to bring you some more good news in 2018. Thank you.