Sapiens International Corporation NV

NASDAQ:SPNS

Earnings Call Transcript 2022-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation's 2022 Third Quarter Financial Results Conference Call. Sapiens third quarter 2022 earnings release was issued before the market opened this morning and has been posted on the company's website at www.sapiens.com. All participants are presently in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session.

I would now like to hand the call to Ms. Dina Vince, Sapiens' Head of Investor Relations. Dina, would you like to begin?

[Dina Vince, Head of Investor Relations]

Thank you operator. I would like to welcome all of you to Sapiens' conference call to review our third quarter of 2022 results. With me on the call today are Mr. Roni Al-Dor, President and CEO; Mr. Roni Giladi, CFO; and Mr. Alex Zukerman, Chief Strategy Officer.

Following the summary of the results, we will all be available to answer any questions. Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements. The Safe Harbor provisions in the press release issued today also apply to the content on 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.

On today's call, we will refer to the non-GAAP financial measures. Our 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 website or via the website's link, which is available in the earnings release we 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, Dina. I want to welcome everyone to our call today. This quarter we delivered solid results despite the currency headwinds. Our revenue reached $119 million and on a constant currency basis we grew 8%. Operating profit this quarter reached $21 million, representing an operating margin of 17.6%. On the constant currency basis, our operating profit margin was 18.9% showing continuous improvement quarter-over-quarter for the past year.

The DNA of Sapiens is coded for growth with profitability. Given the scope of our business, global footprint, broad product offering, large existing customer base, we have many levers we can push to drive our business in challenging times, including managing profitability. So when growth takes longer, we can use competitive advantage to expand our business pipeline access to our existing client base, close new deals and take the necessary measures to improve profitability, despite the effect of currency headwinds.

This quarter we have several examples of how we are doing this successfully. During the third quarter, we successfully expanded our customer base globally. Now more than ever, we are engaging with customer that operates in multi-countries and we can offer them a wider range of products and services. Strategic investments we made in the recent years, such as DACH in the Nordic region have become highly productive.

In North America, we are making significant progress with our three core solutions P&C, Life and Annuity, and workers' comp as well growing with our business application solution like reinsurance and life components. We continue our go-to-market platform offerings with a focus on cloud native deployment, which is our default and preferred approach. More than 90% of our new logo wins are on the cloud. We also see a trend of our existing customers transitioning from brand solution that we sold a year ago to our current cloud solutions.

The global insurance software vertical is highly attractive. We are still in the early days of incredible industry transformation as the insurance carriers continue to transform their core system to remain relevant competitive and compliant. As a global player with multiple product lines and cloud capabilities setting its position in a sweet spot to reach the gain of this opportunity. Our cloud contracts are usually multi-year long-term contracts as well as embedded additional cloud solution, and therefore, increase our revenue by customer for the long-term.

Looking at our regional performance. In Europe, we are proud of our best-in-class products in P&C and Life and our considerable geographic footprint. We are engaging with multi-national higher-sale carriers and seen larger deals that include more products and services. In the DACH region, we expand our presence with an acquisition to 2020. We are becoming a market player, as we win new logos in Germany, while building a solid pipeline for the future.

VH a German leading provider of insurance to the agriculture industry recently signed the second to replace its current system with our modular and complete core systems on the cloud to enable continued end-to-end processing. In addition, another large German player is in the final stage of contracting with Sapiens. In the North America market, our investment across our three core solutions are paying off. In the core Life and Annuity product lines, we recently signed a new contract with a major financial services entity that selects Sapiens tend to deliver its life and insurance services in the Americas.

Sapiens award winning core suite for Life and Annuity and digital suite such solution will provide our next generation customer sales and services experience. Another prospect is currently in the final stage of contracting. In the workers' compensation space, we suffered heavily during the pandemic. We see improvements in the pipeline as well at the same stage that we are involved in. The P&C line of business is gaining momentum with growing pipeline and advancing in the sale stage.

Our business application solution, such as insurance and life components are continued growing. For example, AEGIS, a leading mutual insurance company signed for Sapiens Reinsurance Pro to enhance its new customer internet control process, automatic calculation and reporting. Sapiens Reinsurance Pro replaced AEGIS' current application. As part of our continued enhancement of North America operation, we welcome back Gary Sherne, who is rejoining Sapiens as the EVP Chief Revenue Officer. In his new role Gary will oversee all of Sapiens' North America, go-to-market activities and will be leading the change of accelerated growth by winning new logos and expanding new business with existing customers.

Next week, November 7 to 9, we are hosting our customer summit for North America in Washington D.C. At this event we will meet face-to-face with many customers for the first time in the two years.

Over 450 guests including customer, new prospects, insurer, partners industry analysts and thought leader will participate in over 50 record session over the course of these three days. This event is always a great opportunity to enhance our relationships and showcase our product and solution.

Rest of the world which includes South Africa and APAC are emerging market for Sapiens. We are experiencing a growing demand for Sapiens for both P&C and Life and Annuity. Our rich product portfolio allows us to expand and deepen relationships with our customers and grow our wallet share.

Our digital cloud-native insurance platform provides comprehensive and holistic solution combining core data analytics and digital experience, all deployed in the cloud. Accordingly, most of our new core solution deals include additional Sapiens modules such as Sapiens Intelligence for data and analytics, Sapiens Digital Suite, Sapiens cloud services and our business application.

Our digital offering continues to progress and gain traction both as an integrated module on top of our core solution and as a standalone proposition deployed over non-Sapiens systems. Another example is our latest win in North America.

I mentioned earlier where our digital capabilities were a critical factor in the transformation project. On the M&A front for the last two years we have been active, but decided not to proceed with several opportunities due to high valuations. At this stage, we are evaluating several opportunities for acquisition, but remain committed to our approach of paying reasonable valuation that benefits our shareholders. We have a dedicated team working on the M&A forms.

To summarize, our business is strong. We are growing 8% organically on the constant currency basis, while improving profit and gradually shifting to the cloud. I remain confident about our long-term outlook to our business. There are many aspects of the Sapiens business model that sets us apart from our competitors.

First, a large percentage of our revenue comes from existing customers and we continuously add new customers. Second we have a diverse competitive product offering and thus we have a global scale and cost-efficient operating model which combines offshore and onshore to allow us to remain efficient, while growing. In Europe we continue to lead the market both in P&C and Life in all countries where we operate. And positive about our progress with our North America pipeline and the number of prospects that have positioned us as a preferred vendor and enter the blue field process.

I would like to turn the call to Roni Giladi, our CFO. Roni?

[Roni Giladi, Chief Financial Officer]

Thank you, Roni. I will begin with a review of the third quarter of 2022 non-GAAP results. All comparisons are year-over-year versus Q3 2021 unless otherwise stated. I will follow with comments on the balance sheet and cash flow and wrap up with our guidance for 2022.

Only for this quarter and the remaining part of 2022, we have decided to add additional disclosure to explain the tremendous impact of the currency headwinds on our revenue versus the comparable period. Revenue in the third quarter of 2022 increased to $119 million up 0.5% from the third quarter of 2021.

On a constant currency basis our organic growth rate compared to Q3 of 2021 was 8%. Our revenue would have been $8.9 million higher than in Q3 of 2022. Even when compared to Q2 of 2022 on a constant currency basis our revenue would have been $3.1 million higher than reported.

Our revenue in North America amounted to $49.6 million, slightly higher compared to Q3 of 2021. We see first time that North America will grow during 2023. Our European revenue amounted to $56.9 million compared to $59.7 million in Q3 of 2021. The impact of our weaknesses in European currency versus the USA dollar was material to our revenue from the European region.

On a constant currency basis, our revenue in Q3 of 2022 amounted to $65.7 million reflecting organic growth of 10%. This demonstrates our strong performance and leading position in the Europe region.

Revenue from the rest of world, which includes South Africa and APAC grew 28.6% to $12.6 million in Q3 of 2022 compared to the same quarter of last year. The growth is coming mainly from the P&C. P&C fluctuation in this region was immaterial. Gross profit in Q3 of 2022 was $53.5 million, at a similar level as in Q3 of last year.

Our gross margin this quarter was 45% 10 basis points lower compared to Q3 of 2021. Despite the currency headwinds and increased labor cost we have maintained our gross margin percentage.

On a constant currency basis, our gross margin was 110 basis points higher reaching 46.1%. Operating profit this quarter reached $20.9 million slightly lower compared to Q3 of 2021.

Operating margin amounted to 17.6% this quarter. On a constant currency basis our operating profit margin amounted to 18.9% showing continuous and steady improvement during the past years. This quarter we celebrated growth milestone with over 5,000 employees and contractors and we continue to grow.

Our offshore ratio this quarter passed at the first time 50% benchmark. This is a significant milestone and a key parameter to our continuous improving operating margin. Interest income in Q3 of 2022 amounted to $82,000. During the quarter we had debenture interest expenses of $680,000 offset by income of $60,0000 for mainly interest investment and hedging transaction.

Net income attributed to Sapiens shareholders for the quarter amounted to $16.9 million compared to $17 million in Q3 of 2021. EPS for the quarter amounted to 30 basis points per diluted share, compared to 31 basis points per diluted share in the third quarter of last year.

Turning to our balance sheet. As of September 30, 2022, we had cash and cash equivalents in short-term deposits, totaling $166.9 million and total debt of $80 million, which is scheduled to mature in four equal annual tranches until January 2026. During the third quarter of 2022, we generated adjusted free cash flow of $1.9 million. The low adjusted free cash flow was a result of the delay in timing new deals because of the macroeconomic environment, which translated to reduced upfront payment from new customers, as well as reduction in deferred revenue.

In addition, a contributing factor was a slowdown in collection impacting our DSO that increased from 59.7 days in Q3 of 2021 to 69.1 days this quarter. During the third quarter, we paid a dividend of $0.23 per share reflecting total dividend of $12.7 million for the first six months of 2022. As per our dividend policy, we will announce the second half of 2022 dividends when we publish our Q4 results.

I would like to turn now to our guidance for 2022. In the previous quarter, we have provided guidance that still included $10 million at risk due to the macroeconomic environment, which could cause delay in signing new deals. We now can say that $4 million out of this $10 million at risk materialized. In addition, the European currency continued to weaken versus the USA dollar since our last guidance as of August 3, 2022. The impact of the currency headwind from our previous guidance amounted to additional $3.5 million. Therefore, we are revising our guidance to a new range of $472 million to $478 million from $480 million to $485 million.

At this stage, we are confident in the business. However, we are continuing to be exposed to the FX impact. Our new revenue guidance reflects a growth of 2.5%. If we measure our organic growth on a constant currency basis versus last year, it would have amounted to 8.4%. As we all know, the currency impact on the global companies such as ours that have a large operation in Europe and that report in USA dollar is tremendous this year.

Just to provide a better understanding, USA territory and rest of world were not impacted by the currency headwinds but our European territory lost in a constant currency basis around $27 million in revenue.

Moving to operational margin guidance. Despite the continuous weakening of FX from last year and the previous quarter, we are reaffirming our profit margin guidance range of 17.5% to 17.7%. Our profitability level is affected mainly by our revenue as we do not have a proportional correlation between revenue and expenses in the local currency due to our offshore business model. Our profit is significantly impacted negatively in territories like UK, Denmark, Switzerland, Sweden and is being offset in countries where we have more cost than revenue such as India, Israel and Poland.

To summarize, although our operating margin remained at the same level as of last year at 17.6% on a constant currency basis, we are improving our operation margin to a mid-range of 18.9% in 2022, an improvement of 130 basis points. Sapiens' business model is solid, strong and prove itself even in uncertain times.

From a financial perspective, we continue to grow within our growth range of 8% to 11% organically. We continue to improve our profitability, and we are paying dividend on a semiannual basis.

From a business perspective, we are diversified in many aspects such as having several core systems and business application solutions covering both P&C and Life & Annuity. We are a global company, operating in more than 30 countries. We are providing both licenses and implementation and postproduction services to our customers. And having more than 600 customers with no customers generate revenue higher than 5% of our business and our top 10 customers represent only 26% of our business. All of that provides business flexibility and risk mitigation to our shareholders.

With that, I'm turning it to Roni Al-Dor. Roni?

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

Thank you, Roni. Overall, our business model is built to wisely navigate the changed global economic environment. We are dedicated to driving shareholder value as evidenced by our commitment to growth and improve margins.

And with that, operator, we are now ready to open the call for Q&A.

[Operator]

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] The first question is from Dylan Becker of William Blair. Please go ahead.

[Dylan Becker, William Blair]

Hey guys. I wanted to touch in on the delayed contract that you talked about. I guess, maybe how have the customer conversations continued to trend over the last several months here? How is the emphasis on digitization versus them maintaining that status quo shifted at all? What's enabled them to delay here and has that strategic prioritization on core modernization really shifted at all?

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

Hi, this is Roni Al-Dor. To answer your question there are several topics. The mainly delay, it's on the contract and final decision. I think we continue to see demand from the market. The sales cycle in our business is long. I think at this time everything around the contract and the commercial side and negotiation in this area taking longer and longer. With Sapiens also to protect ourselves, we are also giving some hard time to our customer because we are entering to what we call blueprint stage to make sure that we and the customer understand the size of the deals. And this is the majority of the delay to closing the deals. So we are still seeing demands in terms of competitor situation. We're in a good shape. We have a very good win rate, but it's still delayed because they are all processing.

In sales process you have we call it three phases. You have to bring the opportunity then to sell it to convince the customer that we are the right one and then to close it. The closer part is taking longer-and-longer.

[Roni Giladi, Chief Financial Officer]

Dylan, I would like also to add you asked about also about digital in these deals. We can say that majority of our deals that we are starting today include cloud services and digital solutions. We are happy with it.

And regarding the delay in the decision, this is we can say in very late stage of the process of -- with the customer. And we also had additional solution like mobilization that the customer pays upfront payment for additional work until the legal team, are finalizing some. So we are not saying it will cancel only pushing to the right.

[Dylan Becker, William Blair]

Got it. Okay. So yes, still very late stage more a matter of timing than anything, okay. That makes sense. I guess, two you noted on the call or you just noted earlier in your commentary the emphasis on migrating those existing customers that had made decisions in the past towards your kind of modernized cloud solution here.

Can you walk us through maybe what the economics look like relative to that migration opportunity with those customers maybe compared to a net new deal? And how are you thinking about incentivizing maybe this more captive audience as you think about capitalizing on again the existing customer base which should be lower touch kind of in nature?

[Roni Giladi, Chief Financial Officer]

Thank you, Dylan. So first of all we'd like to split these to two. As the new deal there we see more than 90% of all the new logos that we signed are taking our core system on the cloud and with additional digital services. So this is factor number one.

Regarding the existing customer that we have more than 500 customers that still are not on the cloud this is not a matter of that we can push them. This is time that eventually will evolve. This is a long process existing customers that would like to go to the cloud. It probably will pay additional $1 million or $2 million on a year -- given year.

Regarding auction services Tier 1, we are agnostic to AWS, Microsoft Azure, the IT services and the managed services. So potentially $1 million to $2 million, but again, this is a very long process that will happen in the next few years. We are just starting this process. We can see a few examples that we already succeeded, but it's only the first step in the journey.

[Dylan Becker, William Blair]

Got it. Okay. That makes sense. Maybe one last one if I could squeeze it in here too, around kind of the cloud capabilities in Europe as well. You've been acquiring towards domain expertise here.

Maybe to what extent do you guys start to see that benefit of that local expertise in regions given the complex regulatory framework and maybe some of the international data initiatives proposed in these regions?

It seems like that would be a competitive advantage for you guys. I wonder if you're seeing that play out in your customer conversations. Thanks.

[Alex Zukerman, Chief Strategy Officer]

Hi Dylan, this is Alex speaking. So spot on, I think this is a tremendous differentiator and an added value for us in our European operation. The fact that we can bring on one hand our global view of the industry and our global R&D efforts together with a very strong local presence that resonates very, very well with the local customer base.

So our German teams, and our Spanish teams, and our Danish and Norwegian teams they are making a huge impact and the difference in our ability both to sell and to deliver. We see the customer appreciation for that.

And definitely it is -- it provides us value in a really good understanding of the local capabilities record regulations, local needs and being able to insert them into our R&D plans on a global scale. So we find this combination that works very, very well and very well accepted by the market.

[Dylan Becker, William Blair]

Got it. Thank you, guys.

[Operator]

The next question is from Chris Reimer of Barclays. Please go ahead.

[Chris Reimer, Barclays]

Hi. Thank you for taking my questions. I wanted to ask regarding gross margins. And considering the amount of new logos, you mentioned 90% already a few quarters. It's been pretty high the mix of cloud new deals. When do you think we might be seeing an up-tick in gross margins as a result of the mix in product?

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

So we see up-tick currently already in Q3 in the results. We see the current -- reported one is 45%. But if we look at the constant currency basis we are already at 46.1% more than 110 basis points compared to previous year.

This is coming from -- mainly from the offshore operation. Over the last year we increased our offshore ratio by 5%. We passed the offshore ratio by -- from 45% to almost slightly above 50%. So this is one factor.

The up-tick moving to the cloud will not happen in the first or second year probably will be in the third and going forward because initial steps are additional investment that we need to provide to the customers. So probably from the third year going onwards from new logos moving to the cloud we'll see up-tick also.

[Chris Reimer, Barclays]

Thank you. That's helpful. And just in terms of the delays in deal closings, you may have mentioned it before and I missed it. But is that something you're seeing in a particular region or is that something you're seeing across geographies?

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

We see this trend in global view in North America, Europe, and APAC and South Africa globally.

[Chris Reimer, Barclays]

Great. Okay. Got it. Thank you. That's it for me.

[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, 1-888-269-0005. In Israel, please call 03-9255-938 and internationally, please call, 97239255938. Mr. Al-Dor, would you like to make your concluding statements?

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

Yes. Thank you for joining the call today. We look forward to speaking with you soon. And we are always happy to answer any following questions. Thank you.

[Operator]

Thank you. This concludes the Sapiens International Corporation Third Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.