Sapiens International Corporation NV

NASDAQ:SPNS

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation, Third Quarter 2018 Results Conference Call.

At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded, November 7, 2018.

It is now my pleasure to introduce your host, Mrs. Yaffa Cohen-Ifrah, Sapiens CMO and Head of Corporate Communications. Mrs. Cohen, you may now begin.

[Yaffa Cohen-Ifrah, CMO, Head of Corporate Communications]

Thank you and good day everyone. Our 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. Representing Sapiens today are Roni Al-Dor, President and CEO; and Roni Giladi our CFO.

Before we start, I would like to remind everyone 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.

Also during the course of today’s call, 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 earning release that’s published today.

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

[Roni Al-Dor, President, Chief Executive Officer]

Thank you, Yaffa. In the third quarter we expanded our P&C businesses in U.S. and EMEA markets by leveraging our solution and customer relationships, while continuing to improve the operational performance for our businesses. As a result we delivered a sound performance in the quarter. As evidenced by revenue of $73.2 million, there’s a slight decrease from $73.9 million in the third quarter last year and up from $72.5 million in the prior quarter. We saw a nice step up in our operating margin in the third quarter, which improved year-over-year.

I’m very pleased with the success of our teams in delivering these results and their commitment to our objective to expand our businesses in key markets. In the U.S. we have announced several recent wins, which include our new engagement with Harford Mutual who selected Sapiens North America P&C insurance platform to roll out all Harford Mutual brand of business onto that platform.

A Tier 1 insurance carrier selected Sapiens DECISION manager, our business decision management platform, which had enabled them to modernize their insurance applications. Since the launch of our new digital P&C insurance platform for North America, we have added new customers, and we have expanded our businesses with existing customer while building a strong pipeline in this crucial growth region. Our existing StoneRiver and Adaptik customer, as well as our prospect can see value of Sapiens new and enhanced insurance offering and our commitment to the market.

Meanwhile, our P&C businesses in EMEA continue to grow, and in the third quarter we saw further success in our EMEA long-term and revenue expense strategy. Sapiens IDIT, our flagship P&C insurance suite is extremely popular in this and strategically important for the region.

In EMEA we delivered growth in P&C in the third quarter. We are currently rolling out IDIT with several EMEA customers that choose our solution this year. We remain on track with new customer wins. This market remains very active for Sapiens with the level of deal flow. We have visibility into our future opportunities in this region.

The accelerating pace of change in the insurance industry means that ongoing innovation is critical for our carrier customer. Insurance need solutions to support their businesses growth, and Sapiens innovation solution brings a strategic component that enable insurance companies to improve core offering and to provide the highest level of services for their clients. It is a top priority for Sapiens to expand our competitive position and gain market share in this current environment by expanding beyond our core offering.

At this time, we are again increased our technology capabilities and enhancing new product development through strategic partnerships, which allow us to best manage our capital allocation while improving our digital and debt offering. These partnerships are key to our ability to grow with both existing and future customer.

Our recently announced partnership with FinTLV is a prime example of this strategy. FinTLV is a venture capital fund that provides industry expertise and investments to start-up fintech and insurtech companies. This partnership will leverage Sapiens’ global insurance technology leadership and our extensive product portfolio while giving customer access to FinTLV portfolio for insurance-related companies, along with their expertise in managing innovation program for insurance carriers.

The FinTLV partnership, together with other activities we’re already doing in the insurance space will afford Sapiens access to cutting-edge technologies, creating a strong insurtech ecosystem for our core product and ultimately provide an important differentiator for Sapiens to support our customer.

Our customer cannot afford to sit on the sideline during this period of increasing disruptions. Building the ecosystem of partnership is part of our overall digital strategy, which combines Sapiens’ unique assets around digitally enabled cost system, analytics and digital engagement with innovation cutting-edge solution from our partnership community.

The second digital layer, an API proposition, plays a crucial role in creating an holistic and complete insurance solution to our customer by enabling us to provide an open and collaborative digital insurance platform based on open API layer and our internal software.

Returning to our growing footprint in U.S. market built around acquisition of StoneRiver and Adaptik, Sapiens hosted its largest to-date U.S. client summit with over 440 attendees from 140 companies, including insurance and financial services customer and prospects, who came to discuss current and future industry developments. In this network, we have Sapiens product team and senior management as well as industry experts, leading insurance and financial services companies.

The event gave participants the opportunity to learn about our strength of Sapiens’ product line and to understand our vision for future. Participating in the summit and hearing top industry players strategize about the future confirm for me that Sapiens has the product, the solution, the people and the partners to help insurance succeed in a digital world.

We remain very active with our marketing activities to support our brand and to generate new business opportunity. In fact, after the end of the quarter, we also held another focused customer event in Europe for our live client on the continent, and we are planning to host our EMEA P&C client in a few weeks as well.

Overall, we are working towards building closer client relationship, investing in those relationship and building strong foundation for growth. We see plenty of opportunity to improve what has been principal goal for us this year: cross-selling to our existing customer base.

In the past few years we significantly expanded our solution and services offering with product development initiative and acquisition. Now as we prepare for 2019, the company has made a strategic decision to build a new team that will evolve our customer support model from a silo by business segment approach to customer success teams.

We are recruiting personnel who will be tasked with a broader range of systems ability, including the foundational role of assuring that the customer are pleased and satisfied with their current Sapiens product, this additional role of cross-selling and up-selling and driving awareness of Sapiens product platforms, including our data and digital capabilities amongst our 400 global customer base.

At the beginning of 2018 we stated that our focus in our life segment would be to improve customer satisfaction, driving new businesses from our existing customer. I’m pleased with the progress we have made on this commitment, which has delivered improvement in overall customer satisfaction. I feel we have created a strong foundation for growth in 2019 for these businesses.

As we progress year-to-date, we are confident that we are on track with our strategic plan. We have fully integrated all of our businesses, and we have made substantial investments in our platform and services, and we believe we are well positioned to expand in North American market using the same business model that has been so successful for us in EMEA.

I would like now to turn the call over to our CFO, Roni Giladi. Please, go ahead Roni.

[Roni Giladi, Chief Financial Officer]

Thank you Roni and good morning everyone. Our third quarter revenue totaled $73.2 million, a decrease of 0.8% compared to $73.9 million of last year and up from the prior quarter of $72.5 million.

Our revenue was impacted this quarter compared to Q3 of 2017 mainly by the following: reduction in revenues in Japan and Poland following our strategic decision last year, decrease in revenue in South Africa following the reduction in scope of one of our customers that we mentioned in the past. This reduction was partially offset by the impact of our M&A and new client addition and expanded business with existing customers, particularly in our P&C platform.

Our revenue in North America totaled $36.7 million, an increase of 12% compared to last year. North America this quarter represents 50% of our total revenue versus 44% of last year. Europe revenues, that include U.K., rest of Europe and Israel was 42% and approximately $1.6 million above last year. APAC and South Africa revenues declined following the strategic reduction in activity in Japan and the reduction in the South African customer that we mentioned. To conclude our revenue summary, our P&C business this quarter continued the trend of double digit growth in EMEA and U.S.A.

Turning to gross profit, gross profit this quarter totaled $30.9 million compared to $30.3 million in the third quarter of last year and $30.4 million in the second quarter of 2018. Our gross margin this quarter was 42.2%, up from 41% in the third quarter of last year and 42% in the prior quarter this year.

In the third quarter, we continue our investment in R&D and incurred R&D investment of $9.7 million as compared to $9.8 million in the same period of last year. Although the total amount of R&D investment remained in the same level, we shifted investments through the P&C.

SG&A expenses totaled $11 million compared to $11.4 million of last year and $10.9 million in the second quarter of 2018. We continue to grow our sales for us and presales team while establishing customer success teams. These investments will support our 2019 and onwards goal.

As a result, our operating profit totaled $10.3 million, an increase of 12.4% from $9.1 million in the third quarter of 2017. Operating profit increased 7.3% as compared to $9.6 million in the prior quarter. Operating margin for the quarter improved to 14% from 12.4% in the third quarter of last year and 13.2% in the prior quarter. Operating margin improved throughout the year as a result of our increase of our revenue quarter-over-quarter and the cost reduction program we implemented last year, that positively impact our profitability during the quarter.

Our adjusted EBITDA totaled $11.2 million compared to $10.1 million last year and $10.4 million in the prior quarter. EBITDA margin reached 15.3% compared to 13.7% of last year. Tax expenses this quarter totaled $1.7 million compared to $2 million of last year. We now expect annual tax rate for the year to be around 20% compared to 24.1% of last year.

Net income rose to $7.5 million from $6.3 million of last year and $6.4 million in the prior quarter. Net income margin this quarter totaled 10.3% as compared to 8.5% last year and 8.8% in the prior quarter. The outcome of our operational activities resulted in diluted EPS of $0.15, an increase of 15.4% from both the prior quarter and last year diluted EPS of $0.13.

Moving to our balance sheet, as of end of September 2018 we had cash and cash equivalents of $64.1 million and total debt of approximately $80 million, which need to be paid over the next 8 years. Our first payment is due January 1, 2019. After the end of the quarter, on October 30 we paid a cash dividend of $0.20 per share. Our cash position and improved profitability enable us to pay dividends once again to our shareholders. There were no other material changes in the balance sheet.

As we stated on prior earnings calls, our focus in 2018 was improving our profitability and building the platform for growth. Based on the strength of our results in the first nine months and our outlook for the fourth quarter, we are maintaining our guidance to 2018 full year non-GAAP revenue in the range of $285 million to $290 million. However, we now expect to be on the higher end of this range.

Following the ongoing improvement in operating profit and margin expansion, we are increasing full year 2018 non-GAAP operating margin. We now expect full year operating margin in the range of 13.3% to 13.5% compared to our previous guidance of 13% to 13.2%.

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

[Roni Al-Dor, President, Chief Executive Officer]

Thank you, Roni. Our 2018 priorities remain: continue to expand our P&C businesses, increasing our U.S. presence and continue our EMEA expansion. We are maximizing our investment in leveraging the foundation we have built to drive substantial long-term growth, increase profitability and improve shareholder value.

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

[Operator]

Thank you. [Operator Instructions] The first question is from Tavy Rosner of Barclays. Please go ahead.

[Chris Reimer, Barclays]

Hi. This is Chris Reimer on for Tavy. Thank you for taking my question. You talked about the partnership with insurtech and the fintech startup. Can you give us some color around the strategy and your expectation with regards to the contribution to Sapiens offering from those kinds of partnerships?

[Roni Al-Dor, President, Chief Executive Officer]

Yes. Hi, this is Roni Al-Dor. We are building a consistent partnership with lots of start-up. Fintech is one area that help us to find and to mainly analyze those partnerships. But we are many – as you know, in the industry right now there are many startup in different area. They are knocking in our door and there we are doing some basic integration with them, and we are showing to the customer. So I’d say right now it’s in the early stage, but we believe in the near future we will see more and more partnership. We don’t believe that it will be a big part of our revenue in the next year.

[Chris Reimer, Barclays]

Okay, thank you. You also – you mentioned in your comments a change to sales. If you could elaborate on that a little bit and just how the operation is with sales and cross-selling opportunities.

[Roni Al-Dor, President, Chief Executive Officer]

Yes. With Sapiens also in the last two years we did many acquisitions and right now we have 400 client base and this is a big asset that’s in all of them or close to 100%. We are dealing direct with them without any system integration between us.

So we would like to leverage those assets that we have, and we appointed dedicated what we call today customer success; two years ago it was account managers, but people that will be dedicated on farming and bringing more business to those accounts versus the salespeople are more looking for a new logo. So it’s – we reorganized ourself, but we also add a lot of customer success. Right now, basically we wanted to see the results mainly next year.

[Chris Reimer, Barclays]

Okay. Thank you very much.

[Operator]

The next question is from Avishai Kantor of Cowen. Please go ahead.

[Avishai Kantor, Cowen]

Actually, regarding the cloud-based platform contract which you announced earlier in the week, can you talk maybe – can we maybe discuss the mix within the pipeline of similar cloud-based contracts, and then also maybe discuss the margin profile of similar contracts versus the company’s average?

[Roni Giladi, Chief Financial Officer]

Hi Avishai, this is Roni Giladi. So right now we see the trend of increasing the opportunities on the cloud base. We see this on North America and also on Europe side. We are not talking about SaaS, this is a private cloud, although there are some starting points on the SaaS. The margin profile over the long run will be higher than what we have today. Sapiens is preparing for that and we are answering some demand, the sales team. The announcement of the deal is one example of that. This probably will continue as we go to next year.

[Avishai Kantor, Cowen]

And then as a follow-up, on the insurtech partnerships, do you plan to build an in-house exchange with these partnerships and similar partnerships in order to offer the clients a select, basically of insured products, insurtech products going forward? Is that the long-term plan?

[Roni Al-Dor, President, Chief Executive Officer]

Yes. Again, how to exactly formalize it, but as I mentioned, we are building API in our core product that’s going to enable us to connect much easier with all of those new startup. And definitely, we plan to – it’s like a small lab which we plan to do here and then to show to our customer.

[Avishai Kantor, Cowen]

Great! So we should expect similar partnership announcements going forward over this year?

[Roni Al-Dor, President, Chief Executive Officer]

Yes, many of them.

[Avishai Kantor, Cowen]

And my last question, regarding the over performance in the cost savings, cost takeout plans, can you maybe give us a little bit more detail? You mentioned two things that contributed. One is the scale, and two, your specific actions. Can you give us maybe some specific details about the actions? Are they being driven by G&A expenses? They are obviously not driven by expenses of sale. Are they driven by G&A? Are they driven by shifting headcount to a cheaper location? What – any color on that would be very helpful.

[Roni Giladi, Chief Financial Officer]

Hi Avishai, this is on Roni G. So basically several verticals contribute to this factor of improving the profitability. We started in 2017. We added two efficiency plan. The last one was the end of the year 2017 and now we see the fruit.

We look at all the corporate expenses; IT, legal, HR, finance and we gradually maximize or get efficiency globally from all the acquired entities that we had and build also efficiency in the company; this is one factor. We call it the corporate side.

On the delivery side we started to recruit much more on lower-cost country, Poland and India, in order to improve our profitability on the gross margin as we see right now. And right now we are also continuing to doing this on the R&D. As a matter of fact, we are not stopping on this. We are improving or setting for ourself higher targets.

The India operation that we acquired in 2015 was about 200 employees. We are close to 800 employees right now as we speak, and of course we are planning to pass the 1,000 employees into next year, and we are building the management and infrastructure to support the organization.

Overall, we did some also saving on the sales side, but on area that are not growing at least last year, this was on the sales of the North America, of the life and pension. While we increased the P&C team and as Roni mentioned, we are increasing the customer success team that we didn’t have. All-in-all this contributes to our profitability and we are still building and expecting to improve it as we continue.

[Avishai Kantor, Cowen]

So we should assume most of those actions to continue into 2019, including the hiring as you’ve said, including the hiring in lower-cost locations?

[Roni Giladi, Chief Financial Officer]

The answer is, yes.

[Avishai Kantor, Cowen]

Thank you so much for the details.

[Operator]

The next question is from Mayank Tandon of Needham & Company. Please go ahead.

[Kyle Peterson, Needham & Company]

Hey, good morning. This is actually Kyle Peterson on for Mayank. Thanks for taking the questions. I just wanted to ask a little bit on Europe this quarter. It looks like the revenue on a sequential basis from the second quarter was down a pinch. Just want to see, were there any FX impacts on that, that we should be aware of or how should we look at that?

[Roni Giladi, Chief Financial Officer]

Hi, this is Roni G. As we see compared to Q3 of 2017, we grow the revenue in the Europe and compared to Q2 of 2018 we slightly head down. The main reason for that is the Israel territory and this is coming from the holiday season that we have in Israel that impact our situation and obviously a stronger dollar versus the shekel that impacted the revenue on the Israel territory. Overall, we see growth in Europe in our main product, particularly in the P&C side. So the main reason for reduction is the Israel territory.

[Kyle Peterson, Needham & Company]

Alright, great. And then I just wondered a little bit more on the overall business. I know that you had some strategic stuff with Japan, Poland and then some M&A. Kind of as we step in, I guess beyond the fourth quarter, how should we think about kind of core organic growth, top line growth in the business once we get to kind of lap some of these kind of headwinds and changes in 2018?

[Roni Giladi, Chief Financial Officer]

Hi, this is Roni G again. As we stated in the beginning of the year, we are expecting mid-single digit growth in the company, of course excluding the M&A that come this year, which is Adaptik, KnowledgePrice and two months of StoneRiver and excluding the one-time event that you mentioned earlier.

Overall, the blended is about mid-single digit. If we analyze this deeper, we see decline in the life and pension side, while double-digit growth on the P&C, again both in Europe and in the States. As we speak right now and as Roni mentioned in his comments, we are building or increasing the effort in the sales team in order to improve this growth into 2019 and we are expecting to improve this rate.

[Kyle Peterson, Needham & Company]

Alright, great. And then last one for me, just a modeling question. You know the tax have been coming in a little lower. I think you guys said 20% for the year. Is that 20% rate a good run rate to use in 2019 and beyond?

[Roni Giladi, Chief Financial Officer]

20% is, let’s call it the level that we are feeling conservative with, and we’d like to plan this going forward. This quarter we utilized some tax credit and benefit obviously when we are integrating the entire company altogether and we have several in the last two years. We are planning to utilize additional benefits, but on conservative approach we’ll use 20%.

[Kyle Peterson, Needham & Company]

Thanks, that’s very helpful. Thanks guys. Good quarter.

[Roni Giladi, Chief Financial Officer]

Thank you.

[Operator]

The next question is from Justin Furby of William Blair. Please go ahead.

[Justin Furby, William Blair]

Thanks guys. Just to start on a housekeeping item, Roni G, I’m not sure if you called it out, but for the quarter itself, can you give a sense for organic growth when you net out some of the noise and how it compared to, I think it was 8% last quarter? And then I’ve got a couple of follow-ups.

[Roni Giladi, Chief Financial Officer]

I think – hi, this is Roni G again. So I think the overall if we look at the blended, as I mentioned it’s single-digit growth in this quarter also. But again, its a trend of P&C is growing more than 10%, double digit, very nicely and continue while we see still continued decline in the life. So the answer is about mid to single-digit. P&C is growing double digit, and the life is in decline.

[Justin Furby, William Blair]

Okay, got it. And just to be clear, the P&C double-digit growth, that’s an organic number you are talking about?

[Roni Giladi, Chief Financial Officer]

The answer is, yes.

[Justin Furby, William Blair]

Okay, super helpful. And then maybe for Roni Al-Dor on the new sales changes, just to be clear, does that impact both the U.S. and the European P&C businesses where you are carving out these teams to sell back to the base? And can you give a sense for how much of your new business today is coming from sort of new logos versus selling back to the base and maybe what you hope to accomplish by mixing this up and carving out a special farmer team?

[Roni Al-Dor, President, Chief Executive Officer]

Yes. So you ask a lot of question. I’ll try to hit them all. In Sapiens, for many years we are putting a lot of effort of a new logo. That gives us the confidence that we were the good product and we have the competitive advantage. And in Europe we are definitely becoming one of the – if in the past it was one of the five, one of the 10, right now we believe we are one of the two. We are almost 100% in the short list in every deal on P&C that Sapiens deal with it and then we – 90% of the deal is against Guidewire. So that said, that’s here.

In the States, after we made these four acquisitions in the last two years, we have identified where is the big growth engine and this is the area that we are really focused. We almost built new sales organization, almost from scratch in the last year and based on all the investment in the pipeline, we believe we will see the results on new logo. So again, those are the two big area.

I think on the life side as Roni mentioned, we saw a decline in this year, but now it came to the point that we believe that we will start to see growth again. Not at the same percentage as the P&C, but we definitely – we believe that we will not see declines for sure, not in the near time. So now in the – so, that’s one area. Sapiens again, between 15 to 25 new logo a year, depending on the product.

Now about the client base that we have, as you know the major part of our revenue are coming from our client base; that’s the 400 and this is where we believe that we decide what we are doing today. We plan to do more cross-sell, meaning to get clients that’s bought from us life and now is looking for P&C and more upsell in different type of services. So again, this is why we believe that we have a lot to offer, and we also almost double -- or more than double our client base. So we have much more client base, and we have much more offers, so this is why we are putting all of that, and this is why we invest in the customer success more than in the past.

So just to summarize, we have two organizations, one for new and one for the client base, and we plan to measure them, and we believe both of them can help us to grow.

[Justin Furby, William Blair]

Got it, that’s super helpful. And then I guess maybe one more, the DECISION win at the Tier 1, I thought you said it was a Tier 1 P&C customer. Can you just remind us, I think historically that’s been more financial services and banks? Are you seeing more interest on the P&C side with that product or is that more of a one-off? And who do you compete with in those types of deals typically? Thanks.

[Roni Al-Dor, President, Chief Executive Officer]

DECISION is a generic tool. It’s not building for banks and not for insurance. It’s a tool that allows business people to manage the business logic in a much modern than it was in the past. We started in the mortgage area and then we moved to investment bank, and in the last year and a half we also penetrate the retirement services business and now is for the insurance. So we are going to – most of the client of DECISION are Tier 1. They are using our tool for their entire businesses, more for innovation.

So right now our target is to put more effort to leverage the client base that we have in Sapiens, mainly the Tier 1 and to open doors for DECISION. But in the same time DECISION has a dedicated sales organization and we have now dedicated people who are going after the insurance. That’s in parallel to the banks, so it’s not that we are just focusing on insurance.

[Justin Furby, William Blair]

Yeah, that’s good color. Thanks guys. Nice quarter.

[Roni Al-Dor, President, Chief Executive Officer]

Thanks.

[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 two hours. In the U.S. please call 1-888-295-2634. In Israel please call 03-925-5918, and internationally please call 9723-925-5918.

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

[Roni Al-Dor, President, Chief Executive Officer]

Yes. Thanks for you and thank you for all that participate for joining us on today’s call. Have a good day. Thanks.

[Operator]

Thank you. This concludes the Sapiens International Corporation, Third Quarter 2018 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.