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Magic Software Enterprises Ltd (NASDAQ:MGIC)
Q4 2019 Earnings Call
Mar 9, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Magic Software Enterprises 2019 Fourth Quarter Financial Results Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions].

With us online today are Magic's CEO, Mr. Guy Bernstein; Magic's CFO, Mr. Asaf Berenstin; Magic's VP of Technology & 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 website 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 website.

I will now turn the call over to Mr. Asaf Berenstin, CFO of Magic Software. Please go ahead.

Asaf Berenstin -- Chief Financial Officer

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 organization 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 are 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 demonstrated a solid track record of acquisitions 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 extended their offering for our customers and increased our global footprint. Our recent acquisition completed during the third quarter of NetEffects, a US based company, which specializes in IT staffing and recruiting expanded our footprint in the US market and diversified our client portfolio.

NetEffects team and it's solid customer base that includes several blue chip companies will help Magic fulfill its commitment to its clients to serve as a 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 in our evaluation range. We continue looking for small to mid-size companies with revenues in the range of $20 million to $50 million, which we'll 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 respectively. Looking at the geographical breakdown of our revenues during the fourth quarter, North America accounted for 48% of total revenues, 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 from 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-month period grew 15% year-over-year and our revenues in Israel for the 12-months 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 margin 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 our software solution is due to the acquisition of NetEffects in the expansion of our professional services portfolio. The breakdown of the gross profit mix for the 12-month period of 2019 was approximately 50% related to our software solutions and 50% related to our professional services compared to 56% related to our software and 44% related to professional services in 2018, as a whole.

Moving to operational cost. 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 new 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 first quarter -- 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 $2.9 million -- $2.1 million in the fourth quarter of 2018. Our effective tax rate for the 12-month period of 2018, end of 12 -- 2018 was approximately 19%. We expect our effective 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 share compared to 2018. As a consequence of the company's private placement of 4.3 million shares in the third quarter of 2018 to Israeli institutional investors.

Turning now to the balance sheet, as of December 31 2019, cash and cash equivalents, short and long-term bank deposit and marketable 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 toward our financial institution in the amount of $6 million. Additional $6 million were paid toward amount related to acquisition, of which $4.3 million for the acquisition of minority interest in one of our US subsidiaries, as part of a strategy to increase our share interest in our subsidiaries and $1 million of deferred payment paid toward the acquisition of NetEffects acquired during the third quarter of 2019.

I would like -- 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 maybe 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 the dividend -- as to our dividend policy, we know that it states that in each year of the company will distribute a dividend of up to 75%, with distributable profit, subject to discretion of our Board of Directors to change such percentage or decide not to distribute a 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 toward the end of April 2020. Our Board of Directors will take into consideration among other things, the current and potential effects of the coronavirus on the global economy in general and specifically on our operation in the company's financial needs in light of such effect.

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 outstanding work in 2019. The results we delivered showed 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 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 questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator Instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays -- Analyst

Hi. Thanks for taking my question and thanks for the presentation. 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 -- Chief Financial Officer

I think that on the -- if we start on the margin side, basically we can see that, in 2018, I mean in 2019, our margins were pretty, pretty flat 33% and this is despite, the increase that we experienced in salaries for employees and the investments of the company needs to do is in it's ideas we experience in 2019. So, and this is also with effort to the operating level -- operating margin. So the margin side, I think that 33% is the 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 scale 33% is what we see in the current level today.

Tavy Rosner -- Barclays -- Analyst

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

Guy Bernstein -- Chief Executive Officer

Well, as far as the technology, people, we make sure that all our key and most of the employees of R&D will be able to work from home that means people that do not have laptop today, we are looking, how to equip them with laptops, people that might have a bad Internet connection in their territory, where they leave again if it's in India, in the Pune area, we're making sure that to see how we resolve this is something that we are 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 a quick session with all the employees regarding how to utilize to the best web meetings and online meetings and other tools to actually be effective as possible to continue having internal meeting and the same with customers using all the technology that is available for us.

Tavy Rosner -- Barclays -- Analyst

Great. Thank you. I appreciate the color.

Operator

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

Ted Starck-King -- William Blair & Company -- Analyst

Hey. This s Ted on for Maggie. Thanks for taking my question. So it 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.

Asaf Berenstin -- Chief Financial Officer

Basically, Israel we managed to increase our performance. We have long lasting customers that see us for them of the 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 today around 200 people in St. Petersburg that the support offshore services and we also managed to increase revenues from customers benefiting to work with offshore R&D especially started and local developer. In the same...

Guy Bernstein -- Chief Executive Officer

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

Ted Starck-King -- William Blair & Company -- Analyst

All right,. Thank you very much. And then switching over to guidance here. Could you remind us, so what is your both organic growth in the quarter and how much is contemplated in your full year guidance for 2020?

Asaf Berenstin -- Chief Financial Officer

Basically in 2019 approximately 50% of our growth came from acquisition and 60% came from organic activity. Since we acquired NetEffects at the mid year of 2019 then based on the guidance that we provided between 45% and -- between 33% and 45% of our revenue depends, 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 -- William Blair & Company -- Analyst

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

Asaf Berenstin -- Chief Financial Officer

Yeah.

Ted Starck-King -- William Blair & Company -- Analyst

Okay. And then could you walk us through, and remind us your guidance methodology. How much visibility do you have to your initial revenue guidance for 2020?

Asaf Berenstin -- Chief Financial Officer

On a normal case again putting aside the impact that can be happen from the coronavirus, 80% of our overall of our business is pretty much laid out. We have software -- the software business that generates around $60 million in maintenance and ongoing professional services in addition of $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 partners that develop software applications and buying every year for the new accounts and the existing accounts.

And on the BI side, we are, we are working on existing projects. So we have an outline. I would say normally of 80% of our business. And again before anybody will say for any specific reason that they stop a certain project because what is going on today in the market.

Ted Starck-King -- William Blair & Company -- Analyst

Yeah, definitely. 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.

Asaf Berenstin -- Chief Financial Officer

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

Ted Starck-King -- William Blair & Company -- Analyst

All right. Thank you very much.

Operator

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

Asaf Berenstin -- Chief Financial Officer

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

Operator

[Operator Closing Remarks]

Duration: 22 minutes

Call participants:

Asaf Berenstin -- Chief Financial Officer

Guy Bernstein -- Chief Executive Officer

Tavy Rosner -- Barclays -- Analyst

Ted Starck-King -- William Blair & Company -- Analyst

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