Sapiens International Corporation N.V.
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation Third Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, November 12, 2014. It is now my pleasure to introduce your host, Mrs. Yaffa Cohen-Ifrah, Sapiens' Vice President of Corporate Marketing and Communications. Thank you. Mrs. Cohen, you may now begin.

[Yaffa Cohen-Ifrah:]

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 the company on the call 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 view or expectations or otherwise. Also, during the course of the call today, we will refer to certain 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 webcast link, which appears in the earnings release that we published today. With that out of the way, I will turn the call over to Roni Al-Dor, President and CEO of Sapiens. Roni?

[Roni Al-Dor:]

Thank you, Yaffa, and good morning, everyone. Thank you for joining the call, during which we'll provide the business update and discuss our third quarter and year-to-date 2014 financial results. We delivered another quarter of solid financial results with strong double-digit revenue growth in excess [ph] of 16.7%, ahead of our guidance, while also increase our non-GAAP operating profit. Our revenue growth, which was almost organic, came from all of our growth engines across all territories and from existing and new customers. The investment that we have made in our sales organization are producing results and helping us expedite our market penetration and increase sales, building our pipeline and further expanding our backlog. I'm excited to report that during the quarter, we have successfully gone live with several projects worldwide. Each of them adds another good reference to our portfolio. As I said in the past, in our business, winning a new deal is just the beginning of a long-term relationship, and a key milestone in this relationship is successful delivery and implementing the solutions. We are working very hard to ensure that every customer succeed in his journey. Our long-term relationship and commitment to our customers enable us to further expand our activities within those customer by offering new functionality and new line of businesses and typically lead to an additional significant recurrent revenue stream. Our pipeline is growing, both in terms of quantity and quality. We are seeing faster growth in key geographic regions, especially in the United States and Europe. Our solution are in demand, and we continue to experience positive feedback from customer and industry analysts. I'm excited about where Sapiens is today and about our future. During the quarter, we announced a new significant contract in our DECISION line of business. A U.S. financial firm select Sapiens DECISION as its central application for managing organization of business logic and roles. Deployment of our offering will enable the firm to reduce the cost of implementing a new mortgage platform and provide improved visibility and management of enterprise-wide business logic, including data exchange and acceptances. Central to our solution is The Decision Model, the DECISION management methodology that we acquired through the acquisition of KPI during the quarter. We have invested heavily in important development across all product line to strengthen our competitive position and capitalize on our commercial market opportunity. Going forward, there will continue to be an ongoing level of investment in our product and offering in order to keep our solutions at the forefront of the technology evolution. With the increased product development effort largely behind us, we are reinvesting those resource into sales and marketing. While this has all been expected within the guidance we are affirming today, I think it's important to point out our assumption and expectation for this part of our business. We have recently hosted 3 client events in U.S. focusing in our growth engine, life and annuity, Retirement Services and DECISION, as part of our ongoing marketing efforts and in order to further strengthen our customer relationship. Within in our life and pension and Retirement Services business, we hosted our U.S. life and annuity customer conference in Boston last month followed by a retirement industry event, which was also in Boston. At this event, we had an opportunity to share with prospective customer and clients our vision, address to their business challenge and review new enabling technology to help them to achieve their future state. This event brought together multiple top-tier U.S. prospects and partners for the purpose of showcase our product, capturing feedback and drive interest in our offerings. We received a lot of positive feedback and are looking forward to further our conversation with our clients and prospects, as many of these opportunity do not grow through the traditional competitive bidding and request for proposal. Last week, we hosted the Sapiens DECISION Client Conference [ph] in Washington DC. The theme of this [indiscernible] event was changing the way the business is managed, and we focus on this impact of decision management and what lies ahead strategically for many of our clients and for the industry. In addition to our organic growth, we are also looking for M&A to accelerate our growth. Today, our primary focus remain on acquisition of customer base, geographical expansion and complementary solution. The acquisition of KPI, the owner of The Decision Model patent and boutique [ph] decision management consultancy firm, was closed and funded during the quarter. With the acquisition closed and fully integrated, our end-to-end enterprise offering for decision management, which is unmatched in the industry, positions us well for executing in our joint sales plan to drive growth from this purchase as we head into 2015. I would now like to turn the call over to Roni Giladi to discuss the financial results. Roni?

[Roni Giladi:]

Thank you, Roni, and good morning, everyone. As Roni mentioned, this was a strong quarter for Sapiens, and we continue to see the same trend in the future. We delivered record quarterly revenue, crossing the $40 million threshold for the first time and delivered solid improved profitability even as we continue to invest in our growth. We will be analyzing our result on a non-GAAP basis, which, we believe, better express the operational state of the business. There is a detailed reconciliation to non-GAAP results in the financial tables in the earnings press release. Revenue in the third quarter was record $40.4 million, up 16.7% from the third quarter of 2013. Our revenue for the quarter by type breakdown is as follow

[Roni Al-Dor:]

Thank you, Roni. For the first 3 quarters of 2014, we have consistently increased our revenues across all product lines and geographics. During this period, we have made a major investment in our sales organization with the goal of accelerating our top and bottom line growth. We continue to invest in R&D to maintain our product leadership position and focus on increasing our win rates. Our customers are looking for ways to improve their customer experience and offer better and more competitive products and services. We have a proven track record in helping our customer meet these goals. I look forward to providing you with additional updates during Q4 and full year results. I would now like to turn the call over to the operator for Q&A. Operator, please poll the question.

[Operator:]

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

[Bhavan Suri:]

Roni and Roni, just had a couple of questions. First, on the pipeline comments. When you -- could you give us a little bit more color on the strength you're seeing? Is it in ALIS? Or are you seeing it on the P&C side? And then, maybe also regionally, U.S. versus Europe.

[Roni Al-Dor:]

Okay. We're seeing -- we see the strongest pipeline right now is in ALIS, retail and services and DECISION. We see some slowdown in the P&C in Europe. And about versus in ALIS and DECISION, as you know, we are working with both in U.K. and U.S. So we see a actively a lot of business in 2 of the areas and also in DECISION in 2 areas.

[Bhavan Suri:]

Great, great. And then when you look at ALIS, obviously, you just released the new version, is there something specific? Is there a certain set of features outside of the general trend of insurance companies moving away from sort of the legacy mainframe to the modern Web 2.0-, Web 3.0-type technologies? Outside of that, is there any feature functionality you think you've added to 6.5 that sort of has increased the interest and traction?

[Roni Al-Dor:]

Yes. The 6.5 is mainly technology upgrade. As you know, before that, we are -- ALIS is very rich in terms of functionality. So the main idea of 6.5 is to come with a 3-tier model versus business logic, service layer and presentation layer, and that give -- that's the model system. As all of you know, in all the life and annuity, the competition are coming, which most of them are with legacy system. So with this new technology, we have some differentiator between us and the others. So the answer is definitely, it's -- we have right now one of the opportunity that buy -- bought from us ALIS with a service layer without the presentation layer. Meaning, they are using their unified presentation layer in their system and just us the service layer. And this is the type of thing that company are interesting [ph] right now.

[Bhavan Suri:]

Super, super. And then, as you look at -- obviously, DECISION is term licenses and ALIS is more perpetual followed with services. But as you look at sort of the interest in the pipeline and you look at the growth of licenses, which is not bad, but you -- could you see -- maybe this is a question for Roni G., but could you see the license line potentially accelerate next year?

[Roni Giladi:]

As we all know, we converted to term license in DECISION and potentially as we starting the vertical of Retirement Services, we are considering also to do some term license over there. Obviously, this is an impact on revenue, but building the recurring revenue and repeatable business from those customer for the future ahead. Yes, we considering and looking forward to increase the license price. As a matter of fact, all the projects that we are delivering with our customer today consisting with license and with some additional service revenue, which is basically enhancing and enlarging the product itself by functionality, by country layer, by regulations. And all of that in the future will be able to translate in license revenue.

[Bhavan Suri:]

Okay. And then, I guess, one other one. You touched on Retirement Services and sort of the interest in that space and sort of the prospects in that space. Just a little bit color there, sort of what's the competitive environment in Retirement Services, the 401(k) space? And sort of how big are those projects? And -- because I feel like they're bigger than your typical life projects. But sort of a sense of the size of those projects and the interest in the space and maybe a little bit in the pipeline, specifically for Retirement Services.

[Roni Al-Dor:]

Okay. About the competitive environment right now. There is 2 major competitors to date, DST and SunGard. Two of them are legacy system, 20-plus years. SunGard is more -- DST is more BPO player today. They are the 2 companies that's right now mainly in the market. There is few newcomers, Sapiens is one of them and -- in the record keeping part. There is other ecosystem that we are not compete there, much smaller area like agency, but we are right now integrated with them. So today, on the modern system, today, we are almost -- we don't have any competitor right now. We have 2, 3, but we are the strongest one. We just did 2 things lately

[Operator:]

The next question is from Tavy Rosner of Barclays Capital.

[Tavy Rosner:]

You talked about the expansion of the workforce. So I was just wondering if you could give some color around the geographies and perhaps the product lines.

[Roni Giladi:]

Our teams are basically, we have about 1,000 employees. If I need to spread them on the globe, I would say, about 600 in Israel, 200 in U.K., slightly more than 100 in the States and the rest are in Japan, Australia, Belgium and other countries. So this is a split. Obviously, every year that we grow, we need to increase our headcount. As a matter of fact, in the last 2 years, we grew this almost by 100 employees per year. This required us to do training, explaining about the product line, each one of them. And we continue to do this going forward. As Roni mentioned, we are doing this also based on the pipeline and the growth of each of the product line. So heavily on the ALIS side, but also with the DECISION and the P&C.

[Tavy Rosner:]

Yes, that's helpful. And then, I was looking also at operating margins. You described the improvement that we've seen in the last 3 quarters. Is it fair to assume a similar kind of improvement in the coming quarters?

[Roni Giladi:]

Our primary focus is growth, and this is what we are emphasizing quarter after quarter, and we're trying to achieve this, and we see the results. Of course, given into that, we'd like also to improve the operational profitability, and we are doing this. The last 3 quarter have been showing this. And management objective is to improve this going forward. As a matter of fact, this is something that we are discussing in the management how and to do -- how to do this. So this is a topic that we are looking also to improve in 2015.

[Tavy Rosner:]

That's helpful. And maybe a last one, if I may. You talked about M&A in your prepared comments. I was wondering if you guys have any specific target at the moment.

[Roni Giladi:]

Management, Sapiens is looking for doing M&A basically with several criteria

[Operator:]

The next question is from Richard Baldry of Roth Capital Partners.

[Richard K. Baldry:]

Your gross margins in the quarter were pretty solid, both sequentially and year-over-year, given with licenses sort of softer compared to both 2Q and the year-ago quarter. So typically, we would think that would have a sort of a gross margin drag. So could you talk about the strength in gross margins in your services part of the business? How you feel about utilization there in terms of your capacity to continue to grow with the headcount you've got? Or how much you think you'll have to bring on significant headcount if that utilization started peaking?

[Roni Giladi:]

Yes, so if we look and analyze the result, we see the trend that you mentioned. When we talk to the investor and with the analyst, we mentioned that the gross margin of most or all the division are around the 50%. One which is below this is the ALIS one, and this is taking the company down. This was about a year ago. Since then, we've invested significantly in the ALIS, in the R&D, in the product. This will allow us to improve the efficiency and improve gross margins this quarter and going forward, of course. And this is the reason of the efficiency in the professional services. We'd like to see this trend improvement also in the next year.

[Richard K. Baldry:]

And then if we look at the decision to change to term pricing as opposed to the more upfront or oriented licensing model, could you talk about how much you think that's sort of a short-term drag? What drove the strategy change there on the pricing side and how much you think that going forward, that should build a much bigger recurring base out of the license side of the table?

[Roni Giladi:]

Rich, if you can please repeat the question? Thank you.

[Richard K. Baldry:]

So you talked about changing the pricing strategy on DECISION to more of a term orientation and that, that was part of the license challenge, we'll call it, year-over-year maybe. Can you talk about what's driving that, whether it's customers that, really, are looking for more of a term model?

[Roni Giladi:]

Okay. So we move from term license in the -- not in the first year of DECISION but, I think, in the early years. This is at least 2 years we passed already moving to recurring revenue. If to be realistic, sometimes when we are discussing with customer, some of them prefer to have the term license because they would like to start small divisions, small group and to measure instead of moving to perpetual in the first place. So obviously, we like this approach and we continue and push this forward. Some customers, even the big ones, after they see the good benefit or the potential there, are discussing with us the opportunity to move to perpetual. As the management, I can say to you that we like the term and to continue, but sometimes, it's a matter of negotiation. In terms of how we're looking forward, if I'm looking at the backlog that we have for the end of 2014 compared to the backlog that we started beginning of '14, there is a nice improvement in terms of revenue potential.

[Operator:]

[Operator Instructions] The next question is from AJ [indiscernible] from [indiscernible] Portfolio Management.

[Unknown Analyst:]

I have several questions. I'll ask them one at a time, please. First of all, on the taxes. I see that the tax was very low this quarter. Can you please explain?

[Roni Giladi:]

Okay. So on overall, the tax rate we mentioned should be around the 10% mark up. Obviously, we're working in Israel under a approved enterprise. Some of the entities are -- have some tax benefit that we do not need to pay this year or, for example, next year. And besides, some have additional accumulated losses that we can utilize going forward. I hope this answer your question.

[Unknown Analyst:]

Okay. Second question, please. I see that your goodwill and intangibles started to go down. Can we assume that, that will continue in the near future?

[Roni Giladi:]

On the goodwill and intangible, obviously, we are -- there is an impact of the shekel versus dollar during this quarter in Q3. Most of the goodwill and intangible are in shekel, and this is the primary currency of it. And because of the change in shekel versus dollar, there was devolution in the evaluation of the amount. There is no -- not a P&L impact. All of that go to the equity and do not impact the P&L.

[Unknown Analyst:]

If we compare the depreciation of the intangible versus the capitalization that you do for the R&D, are they about the same? Or is one bigger than the other?

[Roni Giladi:]

In recent quarter, we invest -- and we said we are going to invest heavily in our product in the P&C, mainly in the ALIS also, 6.5 that we mentioned. This is the reason of the increased capitalization in software of the -- in the P&L. And again, this -- as we continue this, we'll see that -- this continue. There is not a big difference, but there is, again, because of the increased investment in the R&D. One comment into that, when we are analyzing the result from economic point of view, we'd like to eliminate the capitalization and amortization because this is the way that we like to measure the company. And when we do this, there is no impact of each one of them.

[Unknown Analyst:]

But I see a decline in the intangible assets. So why is that, if you say that you're capitalizing more than you're depreciating?

[Roni Giladi:]

This is, again, because of the impact of shekel versus dollar.

[Unknown Analyst:]

Okay, okay. So let's talk about the exchange rate, please. So in the past -- in the third quarter, the average exchange rate was a little over ILS 3.50. Now, we're looking at ILS 3.80. Assuming that the exchange rate stabilizes at around ILS 3.80, how do you see that impacting your operating margin?

[Roni Giladi:]

Assuming that the exchange rate dollar versus shekel will stay as we see right now, and this -- the impact to the growth came to -- into Q4, not in Q3 on the average side, we'll see reduce in cost of goods sold and obviously, improvement in operational profit and in gross margin. As I mentioned, about 600 of our employees are located in Israel and cost of it is coming from Israeli -- new Israeli shekels.

[Unknown Analyst:]

So can you help us quantify, in terms of gross margin percentage points, how much -- what the impact is going to be?

[Roni Giladi:]

We are not providing this. I think, based on the information that I mentioned, some rough estimation, there will be improvement if the dollar versus shekel stays as it is, but we are not providing the percentage.

[Unknown Analyst:]

Do you do currency hedging?

[Roni Giladi:]

Yes, of course.

[Unknown Analyst:]

How far out do you hedge your exposure?

[Roni Giladi:]

So right now, if I'm looking at what we have done right now, I think there was a surprise in how the dollar came up very strong this quarter in market. So our hedging didn't took all of it, it took part of it. This is the reason that we have some expenses in the interest income due to that. Obviously, we are going to continue doing hedging for Q4 and at least 3 quarter ahead based on our profitability estimation.

[Unknown Analyst:]

So you hedge 4 quarters -- you hedge the profit -- or you hedge the revenues or the profits for 4 quarters?

[Roni Giladi:]

Our guidance is to do this only on the profit side and not all of it is going gradually as we continue with the quarter. So it's coming with 60% and go to 40% at the end of the profit each quarter.

[Unknown Analyst:]

My last question, please, is with regard to license versus services. I don't really fully understand here. I mean, basically, you're selling software. So I would expect a much larger percentage to be licenses versus services. I mean, does that mean that there's a lot of work in adapting each product to each client? Or what is the reason that the -- because other software companies, usually, the mix is much higher in licenses than services. Can you please clarify that?

[Roni Giladi:]

Yes, I can provide detail into that. So we are not a pure software player. As a matter of fact, if I need to do some comparable, I would say that we are more similar to a on docs [ph] type on the business side. This is in the business model. We are selling cost of the solution for the companies, and the implementation work, we are doing by ourselves. So Sapiens today is the system integrator of the product. What does it mean, services? It means implementation, integration, interfaces. And as I mentioned earlier, we are doing also additional work, which is services, but will help us grow the license in the future, thus, the -- these kinds of work are -- for example, additional functionality that is funded by the customer, additional regulation, additional country layer, additional line of business, all of that is funded by the customer and potentially will increase our co-product and will also increase our revenue license forward.

[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 the participants that a replay of this call is scheduled to begin in 2 hours. In the U.S., please call 1 [phone]; in Israel, please call 03-925-5928; and internationally, please call 972-3-925-5928. Mr. Al-Dor, would you like to make some concluding statement?

[Roni Al-Dor:]

Yes. Thank you for all joining our call today. We look forward to speaking with you again next quarter. Thanks.

[Operator:]

Thank you. This concludes the Sapiens International Corporation Third Quarter 2014 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.