Sapiens International Corporation NV

NASDAQ:SPNS

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation Second Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded August 4, 2020. With us on the line are Mr. Roni Al-Dor, President and CEO; and Mr. Roni Giladi, CFO.

Before I turn the call over to Mr. Roni Al-Dor, I would like to remind participants that this conference call may contain projections or other forward-looking statements, and the safe harbor provisions in the press release issued today also apply to the content of the call. Sapiens 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.

During the course of the call today, we will refer to 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 after the call on our Investor Relations section of the company's website or via the website link, which is available in the earnings release that we published today. As a reminder, the quarterly earnings release was issued before the market opened this morning and it has been posted on the company's website at www.sapiens.com.

I will turn the call over to Roni Al-Dor, President and CEO of Sapiens. Roni?

[Roni Al-Dor, executive]

Thank you, operator. And thanks to everyone joining today to review our second quarter financial results. I will start with an overview of the quarter, followed by an update on our businesses. Roni Giladi will follow with a detailed review of the second quarter financial results and discuss the updated guidance for the year.

Our second quarter results showcase our ability to deliver our solution to our existing customers and onboard new businesses despite the continued impact of COVID restrictions globally. Revenue grew by 17% to $93 million, driven by growth in Northern America and EMEA.

Last week, we announced the acquisition of Delphi Technology, a leading P&C solution vendor focused on MPL, the medical malpractice market in North America. Sapiens will support Delphi customers and products, offer additional products and services to their customer and leverage Delphi's know-how to enhance our P&C CoreSuite to provide holistic multiline solution for MPL market.

We paid $19.5 million for Delphi who had $15 million in revenue in 2019 is an operational loss. Like with our prior acquisitions, we plan to integrate Delphi operation, with our anticipated acquisition, to be accretive in 2021.

The second quarter was productive, thanks to the global Sapiens team effort to deliver new wins, go live and upsell in the quarter. FBAlliance Insurance, a Farm Bureau insurance protection provider, selected Sapiens for its core P&C platform and advanced analytics to accelerate growth and meet demand for rapid launch of new insurance products.

Great Bay Insurance, a New Jersey-based homeowner insurance, selected Sapiens for cloud-based transformation for reinsurance and financial management. Sapiens solution will allow Great Bay to better manage their accounting, finance and reporting system. Implementation of solution is already underway.

Since the beginning of 2020, we experienced a growing traction with our DECISION platform in the insurance market. Following the proven track record with tier 1 banks, now we see a growing interest from insurers using this platform for multiple use cases. Two of our new customers publicly shared the adoption of Sapiens DECISION platform. American Family Insurance will utilize our DECISION platform across various operation companies to create operational efficiency and improving operations. Home Point Financial will be using DECISION to leverage existing technology with a common language between business and domains.

Regional wise, across EMEA and APAC, we are building momentum in the countries we operated in, such as U.K., Nordic, Southeast Asia and South Africa. In addition, we start to expand the footprint in DACH and Iberia region following sum.cumo and Cálculo acquisitions. We continue to integrate these entities into one Sapiens and have seen improvement in their operational performance. Both sum.cumo and Cálculo are well-established in their local market and we are investing in growing the sales and marketing in these 2 regions. The market is positive, accepting the Sapiens global presence and comprehensive product offering that is now supported by local professional teams.

In North America, we are growing our market and wallet share and increasing awareness for our P&C offering as well as getting traction with our Life & Annuities product. Sapiens PolicyPro for P&C, the core components of our CoreSuite for P&C North America, was recognized by Celent as one of the top 5 vendors in the U.S. market, thanks to the rich functionality and advanced technology. Our U.S. team is doing a great job running and expanding our businesses and moving up market.

Our investments in R&D help us maintain the leadership position of our product portfolio. In the second quarter, we made upgrades to a key component in our product offering. For example, our life CoreSuite new release is using cloud-native architecture. It includes reconfigured products and processes that accelerate new insurance product launches. We launched a new version of our cloud-based digital suite for both P&C and Life & Annuities and we have released a new version of our cloud-based insurance underwriting solution with a new reinsurance interface.

In terms of services models, we see an increased demand for managed services across all of our products and regions. Our managed services offering brought tremendous value to our customers during the COVID-19. This platform allows carriers to focus on their businesses while we take care of the technology operational part.

We continue to expand our partner ecosystem to support our customers with the latest insurtech and digital innovation. In early July, we announced a partnership with Quadient Inspire to help our customers drive efficiency by quickly designing, modifying, managing and delivering documents. In another example, Sapiens partnered with CLARA Analytics to provide easy-to-use AI products for our workers' compensation customers.

The current businesses disruption related to pandemic increased the sense of urgency of the insurance company to migrate the legacy platform and create competitive advantage by offering more digital solutions. While improving their operational efficiency, we see an industry-wide trend in which COVID-19 is accelerating the shift to digital platform with the cost efficiency and improving customer experience it brings. This by itself is driving future opportunity for Sapiens. Digital is a key enabling rapid response to the market dynamics, cost efficiency and regulatory change. And our digital offering enables customers to manage core business functions, policy administration, claims and billing and support their digital transformation.

Insurance carriers that look for a new digital platform appreciate the value of Sapiens as a strategic partner for their businesses. We believe that most carriers that started looking for a new system will continue as planned and select a vendor to launch their transformation, or at least start with limited blueprint phases, yet some prospects are taking longer to close their transformation projects.

For the remainder of 2020, I'm pleased to say the deliverables to our existing customers remain on track with a minimal impact on our revenue stream. We continue to see growth in sales for our existing customers, which prove the viability of our partnership for a successful business model. The customer success team is dedicated to expanding our relations with the existing clients and is doing an outstanding job promoting our enhanced digital offering to increase our wallet share. We continue to invest in both sales people and marketing resources to support this growing revenue stream. In parallel, we expect to continue and sign new projects with a new customers that realize that digital transformation is the key to their businesses.

The current environment has changed how we do business development and marketing. Our teams are more focused on developing remote client relations and digital marketing tools to address the restrictive travel and the lack of face-to-face events. This affects the short-term benefit of lowering costs related to travel and marketing. We have accelerated the online engagement model and will conduct our first virtual client conference in the fall. We have also been very active with webinars and remote user groups to replace face-to-face session.

Back to the M&A front, Sapiens has demonstrated its experience in this space with the successful acquisitions we have done to date. Over the past decade, we have completed more than dozen strategic acquisitions to expand our platform capabilities and geographic presence. The acquisitions we made in the past few years in North America, and now more recently in Europe, provide this platform to our future organic growth. We have proven track record to seamlessly integrate acquired companies into one Sapiens, expanding our customer base and product portfolio while merging into one efficient operational organization. This has allowed us to grow our value proposition, expand our operating margin and improve profitability over the past 10 years. We will continue to pursue additional M&A opportunities.

I would like to use this opportunity to share with you that Sapiens was recently added to Tel Aviv-35 Index. The index tracks the price of 35 companies with highest market cap on Tel Aviv Exchange.

In closing, I would like to say that Sapiens global team remains focused on executing our growth strategy. Since we expect new customers will be slow to close, we'll put more focus to leverage the advantage of our large global client base and rich solution portfolios. We will continue to invest in our core and digital offering and devote resources to product development to maintain our leadership position in the market. And we will continue to develop capabilities to meet the growing demand for our cloud and managed services offering. We are well positioned for continued growth in the long run.

I would now like to turn the call over to our CFO, Roni Giladi, to provide more details on our financial results. Please go ahead, Roni.

[Roni Giladi, executive]

Thank you, Roni. I will review the second quarter non-GAAP results, followed by comments on the balance sheet and cash flow and end with our guidance for the remainder of 2020. This quarter was the first full quarter impacted by the COVID-19 pandemic. While we met our revenue guidance, we exceeded our profitability due to measures we took to reduce spending in reaction to the uncertainty of the pandemic.

With regards to our workforce, we reduced our work with contractors and shifted to work in-house. We asked our worldwide employees, mainly on the corporate side, to use accrued vacation days. Industry marketing events and conferences were canceled, and as a result, associate marketing expenses were reduced. Typically, as a global company, our teams are required to travel extensively. This quarter, due to work-from-home restriction and, in many cases, quarantine requirements for travelers, we incurred low travel and accommodation expenses, efficiency measures that we took across all geographies, divisions and departments.

In the second quarter, we froze recruiting. We remained at the same level of employees as at the end of Q1 of 2020, while shifting employees to growth areas. All the above factors reduced our cost and improved our margin in the second quarter. I will provide further detail in my guidance comments concerning the impact on the rest of the year.

Revenue. Revenue in the second quarter of 2020 increased 17% to $93.1 million from $79.5 million in the second quarter of 2019. The organic revenue growth was 10%. In addition, the M&A contribution of our Cálculo and sum.cumo acquisition was 8% and was offset by 1% due to currency impact. Our revenue in North America totaled $46.6 million, an increase of 19% compared to last year, mainly due to strong growth in P&C. Europe revenue totaled $41 million, a 21% increase compared to last year, mainly due to acquisition in the region. Revenue from North America and Europe combined represented 94% of our business.

Gross profit. Gross profit this quarter totaled $41.9 million compared to $34.8 million in the second quarter of last year, an increase of 20%. Our gross margin this quarter increased 120 basis points to 45% from 43.8% in the second quarter of last year. In addition, gross margin increased by 100 basis points from Q1 of 2020.

Operational expenses, R&D and SG&A, including the attribution of Cálculo and sum.cumo increased from $22.2 million to $25.1 million and remained at the same level of Q1 of 2020. Our SG&A costs grew mainly due to an increase of provision for doubtful accounts due to the uncertainty in the market.

Moving to operational profit. Operating profit totaled $16.8 million this quarter compared to $12.6 million in Q2 of 2019 and $14.6 million in the prior quarter. Our operating margin increased in the second quarter to 18%, a 220 basis points improvement from Q2 of 2019 and 190 basis points from Q1 of 2020. If we analyze our improvement from the prior quarter, we see that while we were able to grow our revenue by 2.8% in this quarter, our cost base only grew by 0.5%.

Interest expenses in Q2 were $63,000. This quarter, we had $0.8 million interest expenses related to our debt, while we have $0.8 million income related to hedging transactions. We expect to have quarterly cost of approximately $1.2 million related to debenture in Q3 and Q4 of 2020.

Net income attributable to Sapiens shareholders for the quarter was $13.3 million compared to $9.5 million in the second quarter of last year, reflecting 40% growth. Diluted EPS increased to $0.26 from $0.19 of last year.

Turning to our balance sheet. As of June 30, we had cash and cash equivalents of $128 million and total debt of $120 million spread over the next 5.5 years. To strengthen our balance sheet, in early June, we completed a public offering of $60 million nonconvertible Series B Debenture listed in Tel Aviv Stock Exchange. This raise is at the same term of the debenture we raised in September 2017, and together, represents the total debt we have of $120 million. We completed this raise to strengthen our balance sheet and to provide capital for future M&A.

During July, Ma'alot, part of Standard & Poor's group, reaffirmed the company Israel A plus stable rating. In the second quarter, we achieved $14.7 million in free cash flow. We continue to have high conversion from net profit to free cash flow.

In closing, I would like to turn to our guidance for 2020. Our business model has shown its strength in Q2 during the first full quarter impacted by COVID-19 pandemic and has shown our resilience in this challenging environment. We are benefiting from high repeatable business from existing customers with high stickiness and visibility, which allow us to continue to grow the company.

We are increasing our revenue and profitability guidance. On the revenue side, we raised the bottom range by $8 million and the top range by $4 million primarily due to recent Delphi acquisition. This brings our revenue guidance to a new range of $376 million to $381 million, reflecting an increase of the midpoint by 16.2% year-over-year, of which 8% is attributable to organic growth.

Q2 operating margin jumped to 18%. However, some of the measures taken in Q2 will not continue in the second half of the year, such as the use of accrued vacation days. In addition, we have resumed recruiting employees globally to support our growth, and our marketing activities have also resumed and pivoted to digital strategy.

Based on the above, our operating margin in the second half of the year for Sapiens, without Delphi, is in the range of 17% to 17.3%. Delphi, which we just acquired, will be consolidated in our reporting beginning of August 1. While Delphi will be positive impact on Sapiens revenue, it is currently not profitable on a stand-alone basis.

Based on the above, we are increasing our guidance for the full year consolidated profit to the range of 16.5% to 16.9% from the previous guidance of 16% to 16.5%.

With regard to Delphi, we are entering a process to turn around its business performance in 2021 to Sapiens level of profitability.

To summarize, we remain confident in our outlook for the remainder of 2020 with the following: our ability to achieve revenue growth and expand margin, our cash position of $128 million by the end of quarter, which will allow us to continue to pursue other M&A based on our strategy and our ability to generate free cash flow quarter-over-quarter.

I would like now to turn the call back to Roni Al-Dor for closing comments. Roni?

[Roni Al-Dor, executive]

Thank you, Roni. The customer success team is doing an outstanding job, providing critical support to our customers globally. Sapiens global sales team continue to focus on signing new businesses in these challenging market conditions. Our leadership team remains focused on delivering growth and margin expansion as we execute against our long-term objective of improving shareholder value. Sapiens is well positioned for success and growth.

I would like now to close our prepared remarks and open the call for questions. Operator?

[Operator]

[Operator Instructions] The first question is from Bhavan Suri from William Blair.

[Bhavan Suri, analyst]

Congrats. Nice job there. I wanted to ask just first Roni Al-Dor with you. You've mentioned majority of the implementation work just continued through COVID. I just want to touch on the new deal perspective. You touched it a little bit where you said some delays, but I'd love to understand what you're seeing in the pipeline. How does the pipeline look? And are you seeing elongation of sales cycles? Or are there some deals still happening? I want to understand how the new deal and the new logo works are going?

[Roni Al-Dor, executive]

Bhavan, in terms of new business, we have several challenges. The first challenge is to get the leads. As you know, we are -- the way that we are getting leads is with a lot of marketing events, conference in the insurance, analysts and any kind of digital events. Right now, a lot of them are not working for us. So we are still getting leads through the analysts that most of them highly respect what we are bringing, and from regular marketing. So that's point number one.

The second challenge is the personal relationship and the confidence to give to those customers, that's also a kind of challenge. And the third one is to really close the deals. So those are the challenges.

What we are -- first of all, we are working on all of those challenges, see how we are moving the investment to other type of marketing events, other type of relationship and so on. It's still challenges. But as we mentioned, we are continuing to closing deals and also build a pipeline. I think the advantage that we have in a few of our competitors is the size of Sapiens. That's also, in this time, insurance are -- prefer to working with a big company like Sapiens. We have an outstanding reference, and we know how to work remotely.

So the long answer for your question is there are still challenges, but we are -- we see some -- we see progress.

[Bhavan Suri, analyst]

Got it. Got it. That's helpful. I guess, I want to touch a little bit on Delphi in a second. Just when you look at that in the medical professional liability market, the malpractice market. Just a sense of what the market opportunity looks like there? And who the competitors are, if they're any different?

[Roni Al-Dor, executive]

Delphi is definitely the market leader in U.S. for this. The Delphi challenges was that for many, many years, they lead this business. The main challenge is that Delphi is very good if the insurance is focusing on med mal. If the insurance starts to ask any other line of business, what we call multiline, Delphi has a lot of challenges. And this is why we start to win deals, Duck Creek start to win deals and OneShield. We don't really see a lot of guidewire in this area. So those are the main competitors.

We also won a few deals in the past. Right now, because we have -- already have med mal customer, together with all the knowledge and the knowhow for Delphi, the combination of 2 of them, we definitely, we will continue to lead this market. We have close to 40 customers, it's many. And a lot of knowledge and for many, many years, a very good track record. The main challenge was the technology and to support the multiline.

[Bhavan Suri, analyst]

Got it. And then maybe one last one on the -- obviously, the rev raise for the full year is less than even half of Delphi's revenue. And so just help me understand sort of the conservative piece you're building into the core business, the organic part of the business. Sort of how are you guys thinking about that growth, and sort of -- kind of are you expecting that there are some challenges or slowdown of that business? Or is it just conservative? Just trying to understand sort of what you've built in there for the full year given that the raise was sort of Delphi's revenue only?

[Roni Giladi, executive]

Bhavan, this is Roni G. So if you remember, at the end of Q1 of 2020, we reduced our guidance by 2%. The acquisition of Delphi is, on a full year basis, supposed to be about $6 million. So the increase in the revenue is mainly coming from Delphi. We do not expect right now organically to grow Sapiens stand-alone basis, so the incremental is coming only from Delphi on this revenue.

[Bhavan Suri, analyst]

Got it. If I might squeeze one last one in, sorry, what drove the upside in gross margin? Like why is your gross margin [ up ]? I'm just trying to understand it better.

[Roni Giladi, executive]

Yes. All the factors that I mentioned in my prepared remarks are basically inputs in operational expenses and gross margin. For example, the time off that we ask employees to use across the entire company, the freeze in recruiting, this is another factor that drove gross margin up by 1% compared to the previous quarter. Going further in Q3 and Q4, we do not expect all the things will happen. As I mentioned earlier, we are right now in recruiting mode. We have opened positions of almost 200 employees to support our growth. We are not implementing any use of vacation days. So the gross margin will not be as it's in Q2, but we expect that it will be probably in the mid-range, 45.5%, something like that.

[Operator]

The next question is from Tavy Rosner of Barclays.

[Tavy Rosner, analyst]

Congrats on the strong results. Just following up on your last comment, Roni, on organic growth. So you mentioned that you don't expect a pickup in organic growth this year compared to your previous estimate. And I guess, just looking at the broader context of corona, I would have, on the one hand, expected more insurance companies to kind of turn to you guys for digitalization. On the other end, I understand the marketing challenges given that you can't attend conferences and everything. So would you say, looking ahead to the next 18 months, that the pipeline is kind of growing kind of down the road?

[Roni Al-Dor, executive]

It's a challenging question. In one hand, the insurance companies really understand the demand for digital, and this is a major thing for them. In the other hand, most of them believe that the gross written premium cannot be the same as it was in the past. They are seeing more competition. So all of them understand the demand. The other thing is everything around the insurtech enabled for them to open for them, it's also they need to open their technology.

And the last thing is the expenses. So I think this is also something that Sapiens really helped the insurance companies to reduce long-term expenses. But right now, I think the people are now analyze -- nobody really know for how long this COVID can be, so it's a time that people postpone their decision. So it's difficult right now to give estimates for 18 months. Again, this is the situation that we are seeing right now, and this is why we are taking conservative approach.

[Operator]

The next question is from Bryan Bergin of Cowen.

[Bryan Bergin, analyst]

I wanted to follow up on deal closure. So obviously, I heard the commentary on slow transformational deal progression, but I'm curious if you did see any behavior change as 2Q progressed? And then if you've had anything incremental as far as willingness to sign in July. So really, anything on the margin at least that you're seeing of potential improvement, or has it really just been consistent throughout this period?

[Roni Giladi, executive]

Bryan, this is Roni G. As Roni mentioned, obviously, we see declining pipeline because all of the factors that we mentioned earlier that we do not have opportunity to meet them in conferences, the marketing is moved to digital instead of face-to-face. And people right now are in, let's say, some uncertainty, so putting something in hold. All of that basically reduced the number of new deals that we are signing today, but we are still signing new deals. We did not see a slowdown in July versus Q2.

[Bryan Bergin, analyst]

Okay. And then just on the cost reduction, what efforts are sustainable versus those variable selling expenses and R&D that may come back? I know you had the bad debts provision onetimer in there. Really, are there operational cost efforts that you've been able to pull forward that you think are lasting?

[Roni Giladi, executive]

Yes. For sure, we can do this. What we see is we started the year in Q1 of 2020 with 16.1% operational profit. We now see a Q3 and Q4 at the level of 17% to 17.3%. So for sure, some of the efficiency that we took, we can continue for the next half of the year and going forward. And this is why we are passing the 17% operational margin. So the answer for your question is, for sure, yes.

[Bryan Bergin, analyst]

Okay. And the reason I ask is how should we be thinking about that longer-term margin profile then on the other side of COVID?

[Roni Giladi, executive]

I think on -- going forward, Sapiens need to continue the 17-plus percent. Obviously, sometimes we'll do M&A, and we are pursuing M&A. So the question is what will be happening with the acquisition of any company. In particular, most of the companies that we acquired so far have lower gross margin than Sapiens, so initial few quarters are basically taking us a little bit down. But over time, and we prove it with all the acquisitions that we did, we have been able to do -- to increase them to the level of Sapiens. The same will happen also with Delphi.

[Operator]

The next question is from Omri Velvart from Legacy Value Partners.

[Omri Velvart;Legacy Value Partners;Founder & CIO, analyst]

First of all, congratulations for another great quarter, very impressive. I would like to ask, in your January investor conference in Israel, you talked about the worker compensation product and some major tenders coming in the U.S. I would like to know what's the current situation there with COVID and other related aspect of this field? You've talked about it as a really promising area of your business.

[Roni Al-Dor, executive]

Okay. First of all, good that you listen to all the events, so it's mean that you're okay. And this is -- basically this area, it's really affecting the COVID, all the workers' compensation business. So right now, based on our information, the government is slowing down, and all the RFP they plan to send to a company like us is still in process. Every quarter, they -- we are getting "In the near future, you can get it," and we are still waiting. Right now, we don't really believe that we will get in this quarter. Hopefully, in the next quarter, we will see a few of them. But right now, it's not -- we are not very optimistic to start to get.

[Omri Velvart;Legacy Value Partners;Founder & CIO, analyst]

Okay. The next quarter is actually pretty good for me at least. Another question, please. What -- do you see any change in hiring trends and some -- given capital availability in this environment, you're -- after all, you are a strong and stable company, especially in Israel, but also in other key markets of yours, like Eastern Europe, et cetera?

[Roni Al-Dor, executive]

I can answer the first question in terms of hiring employees. This is better for Sapiens at this point. People -- a lot of start-up are not raising money, so the people are more open and more interesting to come to Sapiens. Also because we are bringing a lot of innovation to our product is also help. So the overall is positive, and also less people are leaving Sapiens in -- like in the past, people had moved from one vendor to another. So right now, it's much more stable. And again -- but it's still -- for good people, it's difficult, like -- but generally, it's on the positive side.

In terms of capital...

[Roni Giladi, executive]

What is the question, Omri, the second one?

[Omri Velvart;Legacy Value Partners;Founder & CIO, analyst]

Human capital, human capital availability, but you answered already.

[Roni Giladi, executive]

Just to conclude on that, in Q2, we froze all the positions that we had. And right now, we are in recruiting mode. We have right now 200 open positions in the company that we're looking to recruit. And as Roni mentioned, in terms of hiring, right now, it's more in favor of companies to recruit in -- let's say, compared to a few months ago.

[Operator]

[Operator Instructions] There are no further questions at this time.

Before I ask Mr. Al-Dor to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin in 2 hours. In the U.S., please call 1 [phone]. In Israel, please call 03-925-5901. And internationally, please call 972-3-9255-901.

Mr. Al-Dor, would you like to make your concluding statement?

[Roni Al-Dor, executive]

Yes. Thank you, operator, and thank you to all the participants who are joining us today. Have a good day.

[Operator]

Thank you. This concludes the Sapiens International Corporation Second Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.