Sapiens International Corporation NV

NASDAQ:SPNS

Earnings Call Transcript 2017-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation’s Fourth Quarter and Full Year 2017 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 March 8, 2018.

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

[Yaffa Cohen-Ifrah]

Thank you, and good day, everyone. Our quarterly earning release was issued before the market opened this morning, and it has been posted on the company’s website at www.sapiens.com. Representing the company 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 looking-forward statements, and the safe harbor provision in the press release issued today also apply to the content of the call.

Sapiens expressly disclaim 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 have 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 link, which appear in the earnings release that we published today.

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

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

Thank you, Yaffa, and good morning, everyone. Many of you joined our conference call three weeks ago, during which we discussed our acquisition of Adaptik and disclosed preliminary 2017 results and 2018 guidance. Thank you for joining us today to discuss our fourth quarter and full year 2017 financial results. In 2017, we made considerable progress in executing in our long-term strategy to become a leading global provider of insurance software solution and services.

We have allocated significant capital to acquisition and R&D to support two elements we believe are essential in execution to this vision. The issues of capital has allowed us to boost our competitive advantage through internal development of product and solution and to move rapidly into key markets where we can acquire new solution, client, personnel and resource and branching focus geographically and market segments.

We seek three over-reaching trends in the insurance market that we look at capitalize on: digitalization, data analytics and legacy transformation. These trends are dominating IT spending for insurance. Insurance company need solution that reduce conflict as they migrate to new software and services, and they require significant support as they navigated these new landscape. In order to best optimize these trends, we have set the following objective: one, to develop our equal, innovating, competitive product and solution set that deliver a clear competitive advantage for core, data and digital; and two, expanding to high-growth market through acquisitions.

In 2017, we made meaningful headway on each of these key objectives. We also set a goal to replicate our success in P&C vertical in Europe and North American insurance market, the largest insurance market in the world and the high-growth market where we plan to increase our presence. This leads us to make a number of acquisition in the market. In 2017, we acquired Stingray and 4Sight. In early 2017, we acquired StoneRiver, and three weeks ago, we acquired Adaptik.

This acquisition provides Sapiens its competitive, comprehensive insurance platform to service all segments in U.S. market: Stingray, for the lower-tier insurance carrier; and StoneRiver and Adaptik for the mid and upper tiers. Each of these acquisition brought additional benefits with new customer, key personnel and new technologies in the way that we could not have done as quickly or cost effectively organically. Following this investment in acquisition we become a leading P&C solution provider in the U.S. insurance market.

In previous years, we have improved our operational platform with acquisition of offshore capabilities in Poland and India. In 2017, we made a strategic decision to focus those organization on customer support, critical component to provide an outstanding customer experience in all portion on our process, from preproduction to production to maintain. Clearly, customer satisfaction is critical to our long-term growth.

In parallel to our acquisition goals, we also made progress on R&D goals. Our investment in technology over the past few years has led to development and released differentiated innovation product, allowing us to expand revenue from both new and existing customer. In 2017, we launched several significant new product and services. Sapiens ALIS 7, an ends with simple technology, enabling insurance to onboarding and administrating individual, group and employee benefit business and support multiple line of business for life, investment and saving, annuity and medical product, all from unified platform.

Sapiens LifeSuite, a full-integrated LifeSuite that includes StoneRiver components and Sapiens Digital Suite, our integrated LifeSuite enable life and annuity provider in North America and around the world to fully digitalize their business, increase automation and agility and transform into data-driven organization. We also launched new version of IDIT. The announced Sapiens IDIT version 14 policy administration suite is designed to meet rapidly changing industry needs, provide insurance and their customer with improved experience and improved operational efficiency.

In addition, in 2017, we create new Digital Division, a dedicated digital innovative group to support growth and digital transformation across the enterprise. This division allow us to improve our go-to-market approach and future product R&D. This new digital business unit is already support our sales and marketing teams and our account manager. Another key assets we add recently was KnowledgePrice, a service provider to leading insurance company in Europe, which brought a team of insurance technology expert.

KnowledgePrice has expansive experience in open technology and agile methodology and best practice surround digital insurance, which has also Sapiens to equip customer with complete digital solution. Today, over 400 customer worldwide use Sapiens solution. We work closely with our customers to maintain their system and maximize their efficiency. During 2017, more than 20 customer go-live and moved into production, which means our solution are now being used as the core operational system. Go-live is a major event for each – for our customer and for us, because a major demonstration for our ability to deliver and support customer’s ability to adapt and roll out new technology across the organization.

We have built the platform for growth in key markets and are positioned to move ahead on our long-term strategy to become a global provider for insurance software and services. While I am pleased with this strategic and operational progress we have made, 2017 was a mixed year for growth and profitability perspective compare to where we began the year. We did report a full revenue of $272 million and increased 25.8% compared to $216.2 million in 2016, preliminary due to addition of StoneRiver revenue.

However, we did not full meet our 2017 expectation of – for profitability, which adjust operation margin for the year of 8.5%. Looking into 2018 and beyond, I recognize that we need to continue to grow. Here’s my plan accomplish the goal: continue to deliver double-digit grow in our in P&C lines in EMEA, enhance our North America P&C business by leveraging the Stream and Adaptik solution to grow revenue while we continue to grow our workers’ compensation and single business in the U.S. and maintain life and annuity business.

We are focusing and continue to support our customer base, providing the highest level of support. These customer are critical for our future growth in the market. We have invest in development and enhance our life product and anticipate returning to grow in 2019, focus on cross-sell and up-sell to our existing customer.

I would like now to turn the call to CFO, Roni Giladi, to discuss our financial results and outlook for 2018.

[Roni Giladi, Chief Financial Officer]

Thank you, Roni, and good morning, everyone. Before I jump into our results for the fourth quarter, as a reminder, we are presenting our results on a non-GAAP basis, which we believe gives a clear view into the operational state of the business. Revenue in the fourth quarter totaled $72.4 million, up 26.9% from the fourth quarter of 2016, mainly due to incremental revenue from StoneRiver in our organic growth. If you analyze our organic growth on a constant exchange rate this quarter, excluding the onetime impact of the lost revenue due to the halt of the project and excluding the deemphasize of non-core revenues in Japan, our organic growth this quarter would have been approximately 10%.

Moving to our geographic breakdown. Our revenue in North America totaled $31.6 million and represent 43.6% of our total revenue as compared to 37% in the same period last year, reflecting the StoneRiver acquisition. EMEA and South Africa revenue of – was 51%. As anticipated, APAC revenues declined following the reduction in revenue in Japan.

Moving to gross profit. Gross profit this quarter totaled $29.5 million compared to $23.9 million in Q4 of last year. Our gross margin this quarter was 40.7%, down from 41.8% in the fourth quarter of last year. Operational costs. Our investment in R&D and SG&A increased during the fourth quarter compared to last year.

R&D expenses in the fourth quarter of 2017 total $9.7 million compared to $6.2 million in the fourth quarter of 2016 and $9.8 million in the prior quarter. The increase in R&D expenses this quarter compared to the same period in the prior year was the result of the full quarter contribution of StoneRiver.

SG&A expenses totaled $10.8 million compared to $10.2 million in last year. SG&A expenses slightly increased despite the contribution of – from StoneRiver, and it was mainly due to the progress we made on reduction SG&A for the combined entity. Our operating income this quarter totaled $9.1 million or 12.5% operating margin compared to $7.5 million or 13.1% in the fourth quarter of 2016.

If you assume a constant exchange rate during the period, our operating margin would have been approximately 180 basis points higher, reflecting 14.2% operating margin compared to 12.5% reported margin, mainly due to the strengthening of the Israeli shekel as compared to last year. Our adjusted EBITDA this quarter total $10.1 million, reflecting 13.9% of total revenue from the quarter.

Financial expenses this quarter totaled $1 million. The financial expenses this quarter included expenses related due to increased expenses on debenture and an exchange rate expenses resulting from fluctuation of exchange rates over net assets.

Tax expenses this quarter were $2 million, representing an effective tax rate of about 24.9% compared to 20.5% last year. The increase in our tax rate is due to the increase in our business in the U.S.A. Net income for the quarter was $6.1 million or $0.12 per diluted share compared to $6 million or $0.12 per diluted share in the fourth quarter of last year.

I would like to note that in the fourth quarter, we completed the deemphasize of our non-core activities in Japan and added additional restructuring expenses related to officers and staff. The impact on the GAAP operating profit was $4.2 million. The total restructuring cost in 2017 was $8.1 million.

Turning now to the full year results for the 12 months ended December 31, 2017. 2017 revenue was $272 million, up 25.8% compared to $216.2 million in the prior year, in line with our full year guidance. Our operating profit in the full year was $23.1 million compared to $29.6 million in 2016, a decrease of 22%.

Our operating margin in 2017 was 8.5% compared to 13.7% in 2016. I would like to remind you that the operating profit margin was materially different between the first half and the second half of the year.

In the first half, the operating margin total 3.9% and was impacted by the halt of development project and the integration of StoneRiver. In the second half of the year, the operating margin was 12.4%. Net income for the year was $15.5 million or $0.31 per diluted share compared to $24.2 million or 49% per diluted share in 2016.

Turning to our balance sheet. As of December 31, we had a cash and cash equivalent of $71.5 million with commitment to pay $20 million from our last acquisition of Adaptik and a total debt of $80 million. Our first debenture principal payment is due January 1, 2019.

I would like to turn now to our guidance for 2018, which we presented to you in February 12. In 2018, we expect revenue of $200 million to $285 million. We expect non-GAAP operating margin of 12% to 13%.

Our outlook for 2018 is primarily the impact by four events: M&A, which will contribute about $21 million to 2018 revenue, however, Adaptik will not contribute the full amount of its acquired revenue due to approximately $5 million of product overlap with StoneRiver. Also, we only have 10 months of consolidated revenue in 2018.

Second, the extension of a project rollout over a longer period than originally forecasted, resulting in reduction of previously forecast revenue of about $10 million in 2018. Third, continued year-over-year reduction in our revenue of about $5 million in noncore business in Japan; and fourth, a reduction in Indian/Poland local market activities in effort to support our main focus of offshore capabilities.

In summary, the Adaptik acquisition, the reduction of non-core business in Japan and the local market business reduction in Poland and India were driven by our goal to improve the revenue mix for profitable growth. While they’re negatively impact the top line in the near term, they position us as a more focused and streamlined company for future, long-term growth.

I would like to note that on March 5, we completed the acquisition of the Adaptik acquisition. Looking at Q1 of 2018, our revenue will be impacted by the reduction in India and Poland local market of activity and the extension of a project rollout over the longer period as we mentioned earlier.

Therefore, Q1 revenue are expected to be between $67 million to $69 million. In Q1 of 2018, we continue our cost efficiency program, mainly focused on the integration between Adaptik and Stream. The cost efficiency will impact our operating margin in Q1, and operating margin is expected to be at the level of 10%.

We will improve our margin gradually over the year to which the full year operating margin guidance of 12% to 13%. As for the tax rate, in 2018, following the U.S.A. corporate tax reform, our blended tax rate is expected to reduce from 24% to approximately 22%.

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

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

Thank you, Roni. In summary, our 2018 priorities will be to continue to grow organically, drive cross-selling to our customer base and achieve non-GAAP operating margin between 12% to 13%.

At the end of 2017, Sapiens significantly enhanced our product offerings by developing and acquiring new solution for core, data and digital to be more competitive. We doubled our customer base and add talent in key areas. We built up a strong P&C platform for North America and streamlined our overall business to build platform to support our long-term strategy.

In 2018, we will be focused on maximizing these strong assets to benefit our existing customer and attract the new ones. With that said, I would like to close our prepared remarks and open the call for question. Operator?

[Operator]

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

[Tavy Rosner, Barclays]

Thanks for taking my question. I was wondering if we could talk a little bit about the life segment. You mentioned in your prepared remarks that you’re expecting stability in this segment in 2018. To me – I recall you guys being a bit more optimistic about life in the past. So can you maybe run us through what has changed, especially in the underlying markets, which makes you less confident about this growth in 2018?

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

Yes. As you know, in the life business in general, we see less deals than the P&C. This is a general statement. And because they are – were a few things that happened to us versus the retirement services in the life, we decide to take more a conservative approach. And we still believe that we – just to remind you that we have three segment in the life: we have our core system ALIS, we have run-off business, or Closed Book and we have the complementary solution that we bought from StoneRiver.

So altogether, we definitely can see growth on the component level. But on the Closed Book and ALIS, we – it’s a long sales cycle, and we – it’s a sink and delay, and we prefer to take more conservative.

[Tavy Rosner, Barclays]

Do you think anything has changed for ALIS on the underlying market? I mean, that insurance company, either is it just sales cycle that are lengthening? Or do you think that they are taking a different approach to using external providers, such as yourself?

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

The main thing is that the market – that there is a lot of consolidation in the life. We just finished a few days with analyst from the – from our business, and those are also – they share with us, there is the – take as an example, income protection in UK. At the past, it was a lot of insurance that – deliberate now. It’s become more commodities, and there is a lot of consideration. That means that our potential customer is less because of the consolidation.

So we don’t – and the other thing is around the Closed Book and runoff business, there is a lot of company are taking for offshore, and sometimes, they have two alternative: or to go to consolidation with our system or to go to direct offshore. And sometimes, they prefer to go to direct offshore. Again, this is what we can see right now, and this is also where we, as a company, decide to focus.

[Tavy Rosner, Barclays]

Thank you.

[Operator]

The next question is from Bhavan Suri of William Blair. Please go ahead.

[Bhavan Suri, William Blair]

Hey guys. Can you hear me okay?

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

Yes. Hi, Bhavan.

[Bhavan Suri, William Blair]

Hey, Roni, hey, Roni, hey, Yaffa. I guess I want to touch on a couple of things quickly. First, can you just talk about the pipeline with Adaptik? It seems like there’s some good opportunities lined up for 2018, but just some sense of size or sort of your confidence and what stage you’re at, close rates, the profits. I just want to get a little more color on that.

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

Okay. I will talk in general about Adaptik, and then Roni can try to add the numbers. As I mentioned, we acquired Stingray, we acquired StoneRiver, we acquired Adaptik. What we – in Stingray is the lower tier. We grow 2017. We have a very good pipeline, so we’re very optimistic that we can grow a high double digit in the Stingray. Now in StoneRiver, StoneRiver, beside the workers’ comp, reinsurance, finance and compliance that was the – that we didn’t do any change, we made a decision – StoneRiver start to develop their Stream system many years ago. It’s a new technology platform and a very, very, very good on claims, and they also start to develop the billings, but very early stage on the policy.

So the main idea is to take the – one of the best policy system in the market today for Adaptik and billing and to combine it with the claim. I just, by the way, came back from U.S. from client conference Adaptik and Stream together. Adaptik, we – you can see in the near future what the analyst believe. They put us in a very – in a magic quadrant, very, very good in terms of what they believe the product. So we are – we feel that, now together with Stream and Adaptik, we can instead of now wait.

If you remember, there is 50 and 80 vendors in U.S. and we can be – after this acquisition, we can be one of the top five. So we are very optimistic. The client base is very happy. The product is mature and strong. Now with the all help of us, because they are relatively small company and they started, by the way, with Tier 1 and 2, it’s very difficult for them to – just because the size.

So I think together with us, with the claim, with the digital, with the services, so we see a lot of potential growth. But right now, we are feeling integration mode, and we are just going to the market right now. The pipeline is good, so we are – yes, we are optimistic.

[Roni Giladi, Chief Financial Officer]

Just to add a small sentence on that. When we completed the due diligence on Adaptik, obviously, we saw a company at the level of $12 million, and we also analyze and review the potential prospect. We feel confident that they will close with Adaptik-Sapiens in the near term and, therefore, potentially will have an impact on the revenue on terms of growth.

In terms of overall size, the Adaptik and Stream claim is altogether, let’s say, between $15 million to $20 million. So this is the area that can grow in the high level. But right now it’s still not a big number. It’s about $15 million to $20 million.

[Bhavan Suri, William Blair]

Got it, got it. That’s really helpful. I think just one other question for you guys generally, and then I might have a quick follow-up there. But have you guys thought about quantifying the cross-sell opportunity between StoneRiver and Adaptik? If you were to think about sort of – both set of customers, the products they have, the products we could cross-sell, how would that look? Or how should we think about the size and opportunity of what you guys might do there?

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

We definitely see we are – already start to – just we feel form from StoneRiver came to the client conference, and again, we are talking about overall StoneRiver has two on this client. I cannot promise that all of them can start to buy but definitely – and by the way, not just Adaptik, also Stingray. StoneRiver, part of their business is legacy, and this is what we are looking for. We are looking to go to all of them and to come with attractive update – upgrade or new version or we can do something good for them. And one, we can keep them, and one, we can see up-sell opportunity. I cannot say give you all numbers, but definitely, this is one of the area that we are looking.

[Bhavan Suri, William Blair]

Yes, yes. I think at some point, it’s worth thinking about that from actual size perspective, potentially. One last one from me. And I know you gave a little color on a large project. You said a little bit about that. But sort of as you think about discussions and how they’re progressing, you think about the cadence and the pace of service in that project, so instead of a big one it’s going to be sort of smaller chunks a few weeks later, how are your guys feeling about that, a little more color? And has there been any progress there? Thank you.

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

Right now, we are – again, we decide to take conservative approach. We have agreement with this large organization but we are – have a lot of stream, a lot of initiative, but we still wants to see how its progress. So we are very optimistic. But in terms of the size – and also, we are taking more conservative approach in terms of 2018.

[Bhavan Suri, William Blair]

Okay, thanks guys. I appreciate it. Thank you for taking my questions.

[Operator]

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

[Avishai Kantor, Cowen]

Good afternoon, guys. Thank you for taking my questions. My first question. So it’s a year passed. The acquisition of StoneRiver was a big strategic move. StoneRiver, it’s predominantly P&C, but if I believe – if I am correct, I think it’s about 20% life. Can you talk – and you touched about it in the previous question. Can you talk a little bit which areas surprised you on the positive side, past – now that the one year anniversary? Which areas specifically remain challenges for 2018? If you can break it down by P&C, of life. I know life is relatively small within StoneRiver, but if you can still break it down by those two segments.

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

I – we definitely not see any surprise in StoneRiver. We are very happy with this acquisition. We – if you can – just to remind, we have the life piece, we have finance and compliance, we have the reinsurance, we have the workers’ comp and we have the Stream, so all of those. As Roni mentioned, we improved the operational margin. We are [indiscernible] on the account management to look after up-sell and cross-sell, and this, we look in the future. The only area that we decide to put more engine is on the three parts.

And this is relatively small, but that’s one of our – can be one of our growth – main growth engine. Again, as I mentioned before, if you can know Sapiens from 2011, we acquired IDIT, and now it’s definitely one of the market leader in Europe in every opportunity. We are in the short list compared to Guidewire. This is what we – our expectation now. We see Adaptik and Stream together to be in the same area in the very near future.

And again, just to remind the people that don’t know Sapiens for many years, this is we try to do for many, many years. We decide not to bring the IDIT to the U.S. like what we did in ALIS. We decide to do few acquisition. Now we complete all of them. We start to integrate, and now we concluded with Adaptik. I think – and again, based on what we overall believe, there is a lot of disruption in the P&C area. So I think we have positioned us one of the very big player on the P&C market.

[Avishai Kantor, Cowen]

Okay. And so do you feel like that you can disclose – if any of those areas you’ve added that you expected in terms of winning new deals? For example, the life segment in – within StoneRiver did a little bit better than you expected.

[Roni Giladi, Chief Financial Officer]

On the life, which I – as Roni mentioned earlier, we are selling their component solution, not the core system solution. And we had several opportunity that we won during this year. They are not big in size, but they are a few hundred thousand each, at least. This was a – in terms of revenue – in revenue size, more than what we expected. So on the life, on the complementary solution, winning new deals with the StoneRiver. And also it refer to the previous question about the cross-selling opportunity for us to do this.

On the overall profitability, Roni mentioned that we have set aside same tools. At the end of 2017, we reached our target to improve the profitability. We are optimistic about this. We reached this goal. There are small areas that we need to be improved. But overall, they are on the level of Sapiens, and so we are also happy with the overall profitability of StoneRiver. As a reminder, we started the year with 8%, and right now, they are in Sapiens level.

[Avishai Kantor, Cowen]

And my last question on the Adaptik acquisition. So it seems like you acquired some tenured IT management capability and C-level executives that are coming from that acquisition. Do you have any plans to leverage them across the organization?

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

Yes, definitely yes. The first thing that we decide to do, we move all the StoneRiver Stream to Adaptik, and we – so the 80% of the management of the new organization, Adaptik and Stream, managed by John, he was the CEO of Adaptik, and all of his management. What we add from Sapiens is the Head of Client and Professional Services, Hagit. She worked for Sapiens, managing the Professional Services. She take over the clients and all the other thing from operation, financial, legal, HR. All of those, they are getting from clients – so from Sapiens. So we definitely want to relieve the CEO from doing the financial part and go to the market and take the advantage to bring more business and serve the existing clients.

[Avishai Kantor, Cowen]

Thank you so much for taking questions, and the color and strategy.

[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 1 888 782 4291. In Israel, please call 03 925 5918, and internationally, please call 9 723 925 5918. Mr. Al-Dor, would you like to make your concluding statement.

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

Thank you, operator, and thank you for all participants for joining us today. Have a good day.

[Operator]

Thank you. This concludes the Sapiens International Corporation’s fourth quarter 2017 results conference call. Thank you for your participation. You may go ahead and disconnect.