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Sapiens International Corporation NV (NASDAQ:SPNS)
Q3 2019 Earnings Call
Nov 4, 2019, 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation Third Quarter 2019 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 4th 2019. It is now my pleasure to introduce your host, Ms. Yaffa Cohen-Ifrah, Sapiens CMO and Head of Corporate Communications. Thank you Ms. Cohen, you may now begin.

Yaffa Cohen-Ifrah -- Chief Marketing Officer & 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 in 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 view or expectations or otherwise.

During the course of today's call, we will refer to non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP result 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 link, which is available in the earning 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 & Chief Executive Officer

Thank you, Yaffa. And thank you for joining us today to review our third quarter 2019 financial results. We entered to the second half of 2019 with strong pipeline of business and our momentum continued to build going into year end. The outstanding third quarter results demonstrated continuous solid execution against our 2019 priorities of topline goals and margin expansion. Topline, non-GAAP revenue in Q3 2019 increased 12.8% year-over-year, primarily due to the expansion in our P&C division and initial growth in our life annuity division.

The global focus on our key objective to leverage our offshore capabilities, along with improved economics of scale drove a non-GAAP operating margin improvement of 240 basis points versus Q3 2018. We continue to invest in our North America segment which is strengthening our pipeline for next year and improving our capability to deliver on current projects. The outlook for our industry remains robust and we are benefiting from global industry trends that are driving our growth. These include first and foremost, technology and digitalization which are the overriding drivers touching all aspects of the insurance industry.

Second, consumer expectation for streamlined interfaces and digital access. As we engage in renewed M&A activity, we are looking to add capabilities, customers and penetrate into new geographies. We are confident that we have the platform to support the long-term topline growth with infrastructure that can cost effective scale and support our long-term profitability. Meanwhile, Sapiens is demonstrated a solid track record of acquisition that have accelerated topline growth and improved our margin through both synergies and scale.

We have proven our ability to successful integrated acquisition and improve the operational performance of the combined entities. As well with acquisition strategy, we have increased our technology and digital products with build customized solution for our customer, and streamline their offering to their customers and provide digital solution analytics and increase our global footprint. Our recent acquisition of Calculo, a leading insurance software solution and services provider for the Spanish market, will expand our footprint in Europe. Spain is the 15th largest economy in the world and fifth largest in Europe. Calculo team of experts, one of the largest insurance system teams in Spain and their impressive customer base that includes several blue-chip companies will help Sapiens to continue it's global expansion. A leading industry research expert, Juan Mazzini for Celent sees this as a perfect time to enter to the Iberian market and he anticipated this market will invest in new system in the near future.

This acquisition is a model for our M&A growth strategy on all fronts. It enables us to expand geographically, both our customer base and add a talented team of experts, as well as complementary capabilities and services for our portfolio. Product innovation is a key differentiator for Sapiens and forms the basic of our appeal to our global customer base, as does our commitment to serve as a one-stop shop for a full set of solutions.

In order to bridge the innovation gap between insurance provider and insuretech company, Sapiens continued to expand this ecosystem. During the quarter, we have expanded our solution set with Kovrr, a predictive cyber risk modeling firm that provides global insurance real-time data driven insight into the cyber risk exposure to help them to meet new regulatory requirements and avoid potentially large policy losses. Recently, we expanded our partner ecosystem with FRISS, an automated fraud detection and risk assessment leader for P&C insurance industry.

Both solutions make innovation in insurtech solution easily available to our insurance care customer. I'm happy to share with you that in the report that was published two weeks ago, Sapiens was recognized again a leader in Gartner's Magic Quadrant for Non-Life Insurance Platforms in Europe for Sapiens IDIT suite. Gartner stated that one of Sapiens strength was with our digital division. We established several partnerships with insuretech to include use case of emerging technology, for example machine learning, IoT and blockchain and that the partnerships developed by us will enable insurers to trail the technology more quickly.

Moving to the deal front. In the third quarter, we closed new business in P&C, as well as life pension. We're yet to [Phonetic] go live and expand our partnership ecosystem. In Europe, we are very pleased to add MSV Life, Malta's largest life insurance company to our growing customer base family. MSV Life chose Sapiens to decommission their legacy system and transform the businesses with Sapiens' innovative CoreSuite which will reduce time to market and cost for future product roll outs. Our life and pension CoreSuite, cloud-based AgentConnect and Sapiens Intelligence analytics will allow MSV rapidly digitalize and make wholesale change without disrupting the core businesses.

Last month, we announced partnership with Atos, a global leader in digital transformation with 120,000 employees in 73 countries. Sapiens ConsolidationMaster will be enhanced by Atos's innovating services and business process outsourcing. This will allow our European customers to manage their legacy portfolio with a wide range of life and pension products by consolidating our services onto one platform.

Atos will dramatically reduce costs and increase efficiency. This new partnership already gained UK customer for Sapiens software solutions. This quarter, our customer Dentists' Provident, a leading provider of income protection insurance in UK and Ireland successfully deployed our CoreSuite for life and pension and implemented our CustomerConnect with the goals of providing streamlined processing, improve efficiency and enhance customer services. Sapiens and Dentists' Provident worked closely to ensure a smooth migration and implementation.

Another go-live in the quarter was S1 Medical, a firm that provides unique niche programs to casualty market in US with the launch of Sapiens ClaimsGo for Workers' Compensation. This was a busy quarter on the marketing and brand awareness front. Sapiens team exhibited in the trade shows worldwide, including the African Insurance Exchange in Sun City, InsureTech Connect in Las Vegas and NAMIC Annual Convention in the National Harbor.

This year, we themed the Sapiens Client Conference, the art of innovation. In September we hosted Sapiens Summit 2019, our annual US client conference. Over 426 participants from approximately 174 organizations attended the Summit this year. Participants, including insurance and financial services customers, prospect and as well as industry experts and insurtech partners. The agenda included strategic discussion presentation of highlight industry development and Sapiens' future vision. On October we hosted our Global Client Conference in Rome. More than 150 participants from approximately 33 organizations, including insurance and financial services customer and prospects discussed the future of insurance industry, trend and Sapiens' strategy and vision. We anticipate a strong finish to the year, with a strong balance sheet, an expanding portfolio of product and solution offering to meet the end to end needs of our clients, offshore capability to support our goals and growing global footprint. Sapiens is well positioned to deliver long-term sustainable growth. I would like to extend my appreciation to the global Sapiens team for their dedication and passion in their work.

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

Roni Giladi -- Chief Financial Officer

Thank you. Roni. I will begin my commentary with a review of the third quarter non-GAAP results, followed by comments on the balance sheet, cash flow and end with our 2019 revised outlook. Revenue in the third quarter of 2019 totaled $82.6 million, up 12.8% from the third quarter of 2018. Our revenue in North America totaled $44.4 million, an increase of 20.9% compared to last year. Revenue in Europe totaled $30.3 million, a 1.1% decrease compared to last year. Revenue in Europe declined compared to last year due to the impact of customer go-lives and currency impact.

The 12.8% revenue growth this quarter represents few organic growth and was negatively impacted by currency fluctuations. Our P&C segment continued to grow quarter-over-quarter, and we started to see initial growth in our life and annuity segment in the third quarter. Moving to gross profit. Gross profit this quarter totaled $36.7 million compared to $30.9 million in Q3 of last year. Our gross margin this quarter increased to 44.4% from 42.2% in the third quarter of last year. The improvement of 220 basis point compared to last year is mainly due to our offshore operation. To give an indication, our India delivery offshore doubled in the last year to support our growth. We have demonstrated improvement in both gross profit and gross margin in the last several quarters and plan to continue to improve it in the future. Moving to operational cost. In the third quarter, we continued our investment in R&D to maintain our product leadership. R&D investments this quarter totaled $11 million as compared to $9.7 million in the same period of last year and $10.5 million in Q2 of 2019.

R&D investments remain approximately 13.3% of total revenue. SG&A expenses totaled $12.2 million compared to $11 million last year and $11.7 million in the prior quarter. Operating margin improved continuously and totaled $13.5 million this quarter, compared to $10.3 million in Q3 of 2018 and $12.6 million in the prior quarter. This quarter, for the first time, we passed the 16% operating margin benchmark and reached record high margin of 16.4%, improvement of 240 basis points compared to last year. While revenue grew this quarter 12.8%, operating profit grew 31.7%, demonstrating our effort to grow in efficient and profitable way.

During the past several quarters, all major Sapiens' currencies, new Israeli shekel, euro, pound, negatively impacted our result, while Indian rupee remained stable. Excluding currency impact, our operating margin will be over 17% with currency as of Q3 of last year. Our adjusted EBITDA margin this quarter reached 17.6% compared to 15.3% last year. Financial expenses this quarter totaled $261,000. The financial expenses this quarter included $630,000 interest expenses on our debenture, that was offset by financial income from hedging transaction to protect our profitability. We do not expect to have this income next quarter. Tax expenses this quarter increased to $2.8 million as compared to $1.7 million of last year with the effective tax rate of 20.9%. Net income attributed to Sapiens shareholders for the quarter was $10.4 million or $0.21 per diluted share compared to $7.5 million or $0.15 per diluted share in the third quarter of last year.

Turning to our balance sheet. As of September 30, 2019, we had cash and cash equivalent of $73.1 million. The balance of our Series B debenture at the end of the quarter is $68.7 million and will be paid in equal annual installments over the next seven years.

Our adjusted free cash flow, which reflect the cash flow generated from ongoing business totaled $16.3 million compared to adjusted free cash flow of $4.2 million in Q3 of 2018 and $14.6 million in the previous quarter. The increase in adjusted free cash flow is an indication to our continuous improvement in our operational profitability and reduction in DSO. This quarter, we had one-time cash payment of approximately $6.3 million related to our investment in new campus in India. In the last day of the quarter, we completed the acquisition of Calculo. While we did not have an impact on the P&L at all, our balance sheet included Calculo balance sheet items with an overall minimal impact.

I would like to turn now to our guidance for 2019. Revenue, looking out to the remainder of the 2019, we anticipate continuing with our organic growth momentum. And following the acquisition of Calculo, we expect to see an increase in revenue due to the first-time P&L consolidation. We are increasing our full-year 2019 non-GAAP revenue to the range of $323 million to $325 million compared to previous guidance of the higher end of $318 million to $323 million.

Operating profit, looking at our Q4 margin, we expect Sapiens' stand-alone operating margin to improve compared to Q3 2019. However, due to the acquisition of Calculo, our Q4 consolidated margin will be slightly down from Q3 record margin. That being said, we are increasing the guidance for the full year 2019 non-GAAP operating margin to the range of 15.8% to 16% compared to our previous guidance of 15.6% to 15.8%. On the M&A front, as Roni said earlier, we just completed the acquisition of Calculo in Spain and started the post-merger integration. We are planning to continue with our effort to find additional companies that fit our strategy which is geographic expansion, complementary products and customer base. We continue to look for small to mid-sized companies with revenue in the range of $5 million to $30 million. In summary, this quarter, we reported organic revenue growth of 12.8%, operating margin at the level of 16.4% and strong adjusted free cash flow of $16.3 million.

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. For the remainder of the year, we will continue to focus on growth and margin expansion. This is a quarter of solid operating results in which we executed well against our long-term objective of improved shareholder value.

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

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, at this time, we'll begin the question-and-answer session.

[Operator Instructions]

The first question is from Mayank Tandon of Needham & Co. Please go ahead.

Mayank Tandon -- Needham & Co -- Analyst

Thank you, and congrats on the strong results. So, maybe first for Roni Giladi. I was going to just focus on the numbers to start with, in terms of your growth rate. So I think looking at the guidance it comes out to about 60% topline growth in the fourth quarter Roni. So I know there's some contribution from the acquisition, but how should we think about the growth trajectory going forward given your pipeline and backlog trends, especially for fiscal '20?

Roni Giladi -- Chief Financial Officer

Hi, Mayank. Thank you for the congrats. And we are looking to have the same momentum as we have building our growing P&C presence in USA and Europe, the same of as we mentioned initial start of the life and annuity starting with Europe and moving to the USA later on. That being said, we'd like to maintain our overall statement. We'd like to have organic growth of the range of 9% to 11% going forward, and on top of that accelerate M&A. Of course, we are trying to achieve more than that, but this is what we are looking forward.

Mayank Tandon -- Needham & Co -- Analyst

Got it. And then given that Europe has been relatively soft, I know there were some maybe one-time factor in terms of customer go-live issue and then you mentioned FX headwinds, but just from a 2020 perspective, how do you think growth shapes out between North America and Europe. Is it going to be more evenly split or will it still be heavily skewed toward North America versus Europe?

Roni Giladi -- Chief Financial Officer

The European, as we mentioned Mayank, again it's one time, we expect to see improvement from the next quarters. It was mainly going live and currency effect. As we mentioned, the pound, euro, also new Israeli shekel affected us. Going forward, today we have stronger pipeline in the State versus Europe, we are seeing right now higher growth in the State than Europe. This is again what we see today.

Mayank Tandon -- Needham & Co -- Analyst

Got it. And then finally on margins, if I could just ask you about again 2020. I know you're not giving specific guidance, but given the progress you've made on the offshoring front and all the leverage that's inherent in the business model, could you talk about the margin expectations for 2020, even just qualitatively if you don't want to give any specific numbers at this point.

Roni Giladi -- Chief Financial Officer

Yes, of course. Our mid-term two years ago was about 17% and during this year we said it will be short to mid-term 17%. This is what we see right now. This is not the guidance, but this is what we said earlier. That need to be taken into effect the acquisition that we just made, usually acquisition that we are doing impact the margin, not the profit, but the margin down. So we need to take this into factor. So stand-alone basis, as I mentioned, this is a target to reach into 17%, with slowdown with the acquisition at least in the first year, which will reduce it slightly.

Mayank Tandon -- Needham & Co -- Analyst

Roni just to put you on the spot, can we then think about margins, maybe in 2020 getting to the upper end of that range that you've guided to, the 15% to 17% with the acquisition lapping at the end of next year. But given, again guess some of the levers that you have been putting in place, can we expect margins to maybe get closer to 17% versus the 16% that we're modeling for 2019?

Roni Al-Dor -- President & Chief Executive Officer

Yes. Then the average of close to 17% seems reasonable.

Mayank Tandon -- Needham & Co -- Analyst

Great. I'll get back in queue. Thank you.

Roni Giladi -- Chief Financial Officer

Thanks.

Operator

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

Dylan Carden -- William Blair -- Analyst

Hey guys, can you hear me alright?

Roni Giladi -- Chief Financial Officer

Yes.

Roni Al-Dor -- President & Chief Executive Officer

Hi, Bhavan.

Dylan Carden -- William Blair -- Analyst

Hey, what's going on guys. It's Dylan on for Bhavan. I guess I just wanted to start off with kind of market macro perspective. Have you guys seen any changes? I know you talked about a strong pipeline in Northeast [Phonetic]. I mean, have you seen any change or acceleration in adoption for these core system solutions in P&C there and then how has cloud conversations trended, have picked up over the last 12 months?

Roni Al-Dor -- President & Chief Executive Officer

No, we continue -- it's Roni Al-Dor. Hi Bhavan. We continue to see a demand in both P&C in Europe and the State. We see a lot of digital interest for this and it's -- we are in a good momentum right now.

Dylan Carden -- William Blair -- Analyst

Okay, great. And then I guess just building off of that as well, I know you guys have focused a lot of your initiatives on North America, building out a new sales team, some sales hires there working on the cross-sell initiatives. Can you guys provide any color on how that's gaining traction out of that maybe six to nine months down the road and then trending compared to your initial expectation?

Roni Al-Dor -- President & Chief Executive Officer

Again this is -- the sales cycle in our business is relatively long, 6 to 12 to 18 months. And also we decide to look after the higher deal. So, definitely, we are building our backlog and pipeline, but it also take time. But we are in the business for many years, so we know. We have also put more effort on the workers' comp business. So it's a part of the P&C business. So it's also -- it's big things, but is also take time. So the overall, we put all the investment in place, we see -- start to see the fruits of the investment, we are also in the same times we build our CC [Phonetic] organization, dealing with our client base. We did a very successful client conference in this quarter. So overall positive. But in this business, things take time.

Dylan Carden -- William Blair -- Analyst

Okay, great. And then one last one from me if I may. Just looking at guidance for the remainder of the year, we had about $1 million beat this quarter and I know you've mentioned that Calculo is expecting roughly $1 million [Phonetic] in revenue for the year and it sounds like from the higher end maybe a guidance bump of $2 million to $3 million. Could you elaborate anymore on the planned kind of good capital are driving growth and then how much of the acquisition played into the guidance raise for the fiscal year. Thank you.

Roni Giladi -- Chief Financial Officer

Hi, Dylan. This is Roni G. The Calculo acquisition as we mentioned when we acquired the company and this is a company at a level of about $9 million to $10 million revenue, not growing at the level of flat. This quarter, we increased the guidance. We continue to grow Sapiens fleet [Phonetic], but we added that additional one quarter or even slightly below one quarter because December is not productive period into the numbers. So altogether, let say about $2 million. The growth that we expect from this region, the Spain, we are planning to have this only in the 2022. 2021 will be to build the pipeline in the organization.

Dylan Carden -- William Blair -- Analyst

Okay, great. Thanks guys for taking my questions.

Roni Giladi -- Chief Financial Officer

Thank you.

Operator

The next question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner -- Barclays -- Analyst

Hi, thanks for taking my questions and congrats on the good results. Just a follow-up question, if I may. I mean, you guys mentioned the solid marketing efforts you did with your conferences in the US and Europe. And I guess comparing this year's conference to last year's conference, like, do you feel that there is more interest than -- i.e. I'm trying to get a sense of your pipeline. You mentioned the long sales cycle, so let's say 18 months from now, do you feel that will be in a much stronger position i.e. things are picking up, insurance companies want to invest more, they want to transform and get your products faster now than they did a year ago.

Roni Al-Dor -- President & Chief Executive Officer

We are doing as you mentioned, a lot of marketing activity. The client conference is mainly to our existing client and, but we are bringing a few prospects from that, that they again, get the confidence from our existing client talk to them, get the confidence and we can see good results after that. And we have the general conference like the big conference in Vegas and all many others that we are doing and definitely put us in a good spot. And we are building our branding and the customer and we are also positioned very high in the analyst community. So we see positive momentum, but again as I mentioned, everything takes time.

Tavy Rosner -- Barclays -- Analyst

Yeah. I appreciate it. And then you know your competitors often talk about moving from perpetual to term and cloud, those all the sexy names and I guess, when do you think that Sapiens will be ready to start disclosing, start breaking it down, cloud revenues, term versus perpetual? Where are we? Are we early stage or where are we on that journey?

Roni Giladi -- Chief Financial Officer

Hi, this is Roni G. First of all, we are early in this journey but we are investing in this a lot. You mentioned the cloud, we open infrastructure to move people on the AWS Azure infrastructure. We are building team in offshore location to be more profitable on that area. These things take time. On the sales side, I can say that all the new deals that we are getting, all that RFP that we are getting from the state, about 50% of them are cloud requested and we have been able to answer this demand. Europe is slightly less than this, we are talking about 30% of the new deals that we are signing.

So now moving forward with it full speed. But these things take time, and only we are building the new layer, the existing layer is obviously on the different infrastructure.

Tavy Rosner -- Barclays -- Analyst

And as a follow on to that, I mean let's say, not talking about cloud but even on-prem, you would say what percentage of new contract at least RFPs are still for perpetual? Do you still have those or new contracts are on term one?

Roni Giladi -- Chief Financial Officer

Starting from 2019, we took a management decision that all deal will be on the term license, moving from perpetual license. We started it, implemented it. I can say that majority of the deals that we're signing today are term license. We will not lose the customer because of that, but we are significantly moving into them.

Tavy Rosner -- Barclays -- Analyst

Perfect. I appreciate it. Thank you, guys.

Yaffa Cohen-Ifrah -- Chief Marketing Officer & Head of Corporate Communications

Thank you Tavy.

Operator

The next question is from Bryan Bergin of Cowen. Please go ahead.

Bryan C. Bergin -- Bryan C. Bergin -- Analyst

Hi, thank you. I wanted to ask on the life & annuity business, your comment here on initial growth. Can you give us a sense of scale of that? How we should be thinking about growth from here in that product base? And then just can you remind us the scale of that business today?

Roni Giladi -- Chief Financial Officer

Hi, Bryan. This is Roni G. Today, the life & annuity represents about I would say 20% of the business, slightly more. We are seeing initial growth, it's not significant, but we see the trend, we talked about in the last two years that this is in decline mode, customer going live and there is no new business coming in. So right now we see initial, it's small amount right now, but for sure the initial target for this year was stabilization, we may exceed it. So this is number one. We mentioned this quarter about two deals. One of them was in UK, the Atos and the other one was MSV Life. I think two things that on the life side that give us momentum and also we see nice pipeline building, by the way also small ones in the State and Europe to build this growth future. We are not giving guidance for this by vertical, but for sure we see change in the trend.

Bryan C. Bergin -- Bryan C. Bergin -- Analyst

Okay, sounds good. And then as far as Europe goes, can you just comment on the outlook there, really the client tone and the pace of decision making. And then I don't know if you scale this, but what was the FX impact, whether it's just in Europe or the overall company on revenue?

Roni Giladi -- Chief Financial Officer

Yes. And the majority of the FX was in Europe a few percentage point for the European one 3% to 4%. Then this with additional going live on the European side, I think we will see from the next quarter increase in the revenue in Europe. We do not see any delay in decision because of the Brexit or things like that. We are very strong today in the UK. Nordic, we'd like to expand in this region in Europe. I think we completed Calculo, this is one area for us for growth. Again we mentioned we are planning to see growth there in 2022 and as we mentioned earlier, we are still moving ahead with M&A front to establish or expand our presence in Europe.

Bryan C. Bergin -- Bryan C. Bergin -- Analyst

All right, thank you.

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 US, please call 1888-295-2634. In Israel, please call 03-925-5901. And internationally, please call 972-3-925-5901. Mr. Al-Dor, would you like to make a concluding statement?

Roni Al-Dor -- President & Chief Executive Officer

Thank you to operator and thank you to all the participants for joining us today's call. Have a good day.

Operator

Thank you. This concludes the Sapiens International Corporation Third Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

Duration: 39 minutes

Call participants:

Yaffa Cohen-Ifrah -- Chief Marketing Officer & Head of Corporate Communications

Roni Al-Dor -- President & Chief Executive Officer

Roni Giladi -- Chief Financial Officer

Mayank Tandon -- Needham & Co -- Analyst

Dylan Carden -- William Blair -- Analyst

Tavy Rosner -- Barclays -- Analyst

Bryan C. Bergin -- Bryan C. Bergin -- Analyst

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