Yaffa Cohen-Ifrah - Chief Marketing Officer & Head, Corporate Communications Roni Al-Dor - President & CEO Roni Giladi - CFO.
Justin Furby - William Blair Avishai Kantor - Cowen & Company.
Ladies and gentlemen, thank you for standing by. Welcome to the Sapiens International Corporation Third Quarter 2017 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, November 9, 2017. It is now my pleasure to introduce your host, Mrs. Yaffa Cohen-Ifrah, Sapiens' CMO and Head of Corporate Communications.
Thank you, Mrs. Cohen, you may now begin..
Thank you, and good day, everyone. Our quarterly earning's 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 forward-looking statements, and the safe harbor provision in the press release issued today also apply to the content of the call.
Sapiens expressly disclaims any obligation to update or revise any of these forward-looking statements, whether because of future events, new information, a change in its views or expectations or otherwise. Also, during the course of today's call, we will refer to non-GAAP financial measures.
A reconciliation schedule showing GAAP versus non-GAAP results 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's website or via the website link, which appears in the earning release that we published today.
I will turn the call over to Roni Al-Dor, President and CEO.
Roni?.
Good morning, everyone. Thank you for joining the call today. I'm very pleased with the results of the third quarter and would like to thank our global team to their hard work. We showed solid improvement evidenced by solid revenue growth of 30.8% improvement in operational profit and increased net income.
We are very pleased with progress we have made integrating StoneRiver. As I mentioned in our previous call to date we have fully merged each StoneRiver division with its peer division at Sapiens. We also manage all of our U.S. P&C activities into one group. As of now, all of our corporate function and back office operation are fully integrated.
We have also merged each of our sales and marketing organization of StoneRiver and Sapiens into one organization, while adding account manager to support and growth of our business in the existing clients. I would add that we saw our organic growth in StoneRiver acquisition, we merge different company then we were just two years ago.
Our employee base grew from 1,500 employees to more than 2,500 across the globe. We are proud now to have over 400 insurance companies that partner with Sapiens for success.
Today Sapiens' position is a leading innovating software solution provider offering end-to-end solution to global insurance industry, while creating greater value for our customer and shareholders. On the deal front, during the quarter, we are pleased to go live with budget direct insurance in Singapore.
We can now offer customizable policies critical for digital life insurance business along with flexibility to quickly release new Telo [ph] product. Also last week, we announced that RLI, an Illinois based specialty P&C insurance selected our StoneRiver billing system to consolidate its current billing system.
The billing system will be deployed in cloud for even greater efficiency. We are working closely with our customer and prospects to make sure we address their current and future business need. At our global client conference recently held in Portugal, we offered over 120 participants from 11 countries.
We talk in a detail about Sapiens sense of urgency, constantly improvement of our business to deliver leading solution for the mission-critical needs of our market. The agenda include a range of speakers that provide the audience with variety of insights into Sapiens people and product, as well as industry hot topics.
Our customer shared multiple case studies and various plan as we discussed, the changing trends in the insurance market with customer and Sapiens expert. Insurance carriers are migrating legacy system, maintaining regulatory requirement and managing complex product. We must be there and support their journey.
In our client conference, we emphasize on our commitment to bring our customer best technologies, solutions, processes and the technologies that will help them to embrace the change. We continue to move faster, but also closer to our customer. Today we have a multiple offices that are located close to our customers.
Recently, we have opened three new offices in Nordic region, South Africa and Turkey, to enhance our local presence and support our local customers. We also have established several center of excellence, which help us at the back office, accelerate product development, and offer a mix of new capabilities and cost models.
With the rise of the mobile connected consumer, the growing penetration of new technologies, consumer expectations of evolving businesses are responding. The insurance industries undergoing its biggest revolution in the decades, transforming the way they deliver services to their customers.
They need new product, they are flexible, personal [indiscernible] and supported by system and processes to meet the growing demand for the non-demand information in mobile application. This mean, we must keep on moving, because if we don't, we will fell behind.
Sapiens is moving fast to support these changes by adopting new technology and improving best practice and engagement. Our mission is to invest innovation to enable the insurance carrier to transform their businesses. We are investing in new product to complement our core offering and entering new services model to give customer more flexibility.
In order to meet our customer conformation and digital journey, we have aligned the way that we operate globally. Our core division life and annuity and P&C are now enhanced with corporate level CTO and product strategy.
On top of that, we have established a new division that is focused on digital offering that will provide digital product and services across all Sapiens.
In addition, we create a product strategy function that is responsible for the go-to-market strategy and product innovation across all of our insurance product portfolio globally and work closely with the product, sales and marketing, client relationship team to build and communicate our unique product value proposition, while maximizing synergies across product.
I'm pleased to announce that Sapiens was selected as the one of the five leaders in Gartner Magic Quadrant for life insurance policy administration system in Europe. The initial pull of 50 vendors across Europe was based on categories ranging from product development and maintenance, digital accelerators and vendor viability and success.
This recognition, the present investment we have made in Sapiens ALIS, one of our flagship solution into service Europe in an area of strategic importance to us. In summary, this quarter, we posted solid revenue gains of double-digit growth driven by mix of organic growth and acquisition of StoneRiver.
Due to cost saving initiatives and the progress on the integration of StoneRiver, we improve operating margin to 12.4% and remain on track to achieve our goal for the year. As a technology and solution provider focus on the insurance market, we remain committed to bring our current customer to the best technology, solution, process and methodologies.
And we will continue to make investment in both R&D and product development to deepen our core product and services offerings.
We see substantial opportunity to continue organic goal with both current and new customer, and we pursue additional goal to acquisitions where it make business sense for new products, new market and even new partner who can bring us more customers.
I would like now to turn the call over Sapiens' CFO, Roni Giladi, to discuss our financial results and outlook for 2017..
Thank you, Roni, and good morning, everyone. Our third quarter result showed a significant operating profit and margin improvement we have made compared to the second and the first quarter of this year.
Revenue in the third quarter totaled $73.9 million, up 30.8% from the third quarter of 2016, mainly due to incremental revenue from StoneRiver and our organic growth.
If we analyze our organic growth this quarter, excluding the impact of the lost revenue due to the halt of the development project, and excluding the non-core revenue that we decided to deemphasize in APAC. Our organic growth rate this quarter would have been approximately 16%.
If we analyze this organic growth on a constant currency basis, our organic growth rate this quarter would have been slightly less at 14.5%. This quarter, the euro and the shekel strengthened compared to last year, affecting positively our revenue.
Moving to our geographic breakdown; our revenue in North America represents 44% of our total revenue, as compared to 35% in the same period of last year, reflecting the StoneRiver acquisition. The U.K. revenue was 14.7%, and the rest of Europe and South Africa were 33% of total revenue.
And as anticipated, APAC revenues declined following our strategic decision to deemphasize non-core revenue in that region. And we continue to anticipate decrease in the coming quarters. Moving to gross profit; gross profit this quarter totaled $30.3 million compared to $23.6 million in Q3 of last year, and $26.4 million in Q2 of 2017.
Our gross margin this quarter was 41%, down from 41.8% in the third quarter of last year, and up from 38.2% in the prior quarter. The increase in gross profit dollar versus last year was mainly due to StoneRiver consolidation, and the impact of our restructuring program.
On a constant exchange rate, gross margin this quarter would have been higher by approximately 100 basis points reaching 42%, and similar to the third quarter of 2016. The Israeli shekel had a negative effect this quarter on our gross and operating margin. Moving to operational cost; our investment in R&D and SG&A increased during the third quarter.
R&D expenses in the third quarter of 2017 totaled $9.8 million compared to $5.8 million in the third quarter of 2016. And $10.8 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.
The reduction in R&D compared to prior quarter was mainly due to the planned completion of the elevated investment in ALIS capabilities and efficiencies. SG&A expenses totaled $11.4 million compared to $10.4 million in the third quarter of last year, and $12.4 million in the prior quarter.
The increase versus last year was primarily due to the full quarter contribution from StoneRiver. The decrease compared to previous quarter was due to the progress we are making on reducing SG&A for the combined entity as we progress on executing against our integration plan and realizing synergies.
As we discussed in our previous call, we have fully integrated all of StoneRivers' corporate function and back office operations with Sapiens, and we are now operating as one cohesive company.
Our operating income totaled $9.1 million or 12.4% operating margin compared to $7.3 million or 13% in the third quarter of 2016, and $3.2 million or 4.7% operating margin in the second quarter of 2017.
The improvement in operating margin compared to the prior quarter is primarily due to restructuring and cost saving initiatives we implemented in prior quarter that included synergies and integration between Sapiens and StoneRiver division.
Reduction of R&D investment following the completion of the development effort for the ALIS group capabilities, alignment of the sales and marketing organization of StoneRiver and Sapiens, integration of all of our corporate function and back office operation including IT, finance, legal, HR, and purchasing and the beginning of offshore program with Sapiens' capability to drive additional efficiencies in StoneRiver.
If you assume a constant exchange rate during the period, our operating margin would have been approximately 160 basis points higher, reflecting 14% operating margin compared to 12.4% reported margin. Our adjusted EBITDA this quarter totaled $10.1 million, reflecting 13.7% of total revenue for the quarter.
And again if you assume a constant exchange rate during the period our EBITDA margin would have been approximately 15.3%. Financial expenses this quarter totaled $863,000 compared to financial income of $225,000 in the third quarter of 2016.
The increase in financial expenses is mainly due to expenses related to our hedging and interest expenses on the bank loan and debentures. I would like to note that the bank loan was repaid on September with proceeds from the recent Israeli debt offering.
Tax expenses this quarter were $2 million representing an effective non-GAAP tax rate of about 24%. Following our acquisition of StoneRiver, our tax rate is expected to increase to the level of 25%.
Net income for the quarter was $6.3 million or $0.13 per diluted share compared to $6 million or $0.12 per diluted share in the third quarter of last year, and $1.9 million or $0.4 per diluted shares in the prior quarter. I would like to note that we did not complete yet the deemphasize of our non-core activities in APAC.
We expect to complete it by end of year. As I said in the previous call, initially we anticipated total restructuring cost to be up to $5 million. In the second quarter, we reported $3.9 million restructuring costs and the remaining balance will be recorded during Q4 of this year.
Turning to our balance sheet; during the quarter we completed on Israeli public offering in which we raised $70.1 million of series B debentures offering.
The debenture are listed for trading on Tel Aviv Stock Exchange and bear effective interest rate at an annual rate of 3.7% with a semi-annual interest payment commencing in January 2018 and annual principal payment commencing in January 2019 to be made through the maturity date of January 1, 2026.
The offering was part of our continuous effort to optimize our balance sheet and capital structure. Our goal with the offering was to strengthen our balance sheet to provide additional working capital to support our customer development needs and to continue to pursue M&A business opportunities we'll see ahead.
We used portion of the fund to repay the existing bank loan. As of September 30, we had cash and cash equivalents of $80.5 million and total debt of $78.2 million after paying the $38 million debt. The accumulated GAAP operating cash flow this quarter totaled $5.1 million compared to $24 million in Q3 of 2016.
The main reason for the decrease in cash flow was the GAAP operational loss in the first half due to the halt of the development project and the restructuring plan. I would like to turn now to our guidance for 2017.
We are maintaining our guidance for 2017 full year revenue of $265 million to $275 million on a non-GAAP basis, which we now expect to be on the higher end. We are also maintaining expectations for the full year operating profit margin between 9% to 10% on a non-GAAP basis which will be on the lower end of our guidance.
We continue with our efficiency and improvement program and expect to continue our trend of operating margin improvement with higher Q4 margin compared to Q3. I would like now to turn the call back to Roni Al-Dor for closing comments.
Roni?.
Thank you, Roni. Overall, we delivered double-digit growth for the quarter; we remain very excited about the acquisition of StoneRiver and its contribution to our overall businesses and addressable market opportunity. Our businesses remains strong and customer demand for our product and services remain high.
We are confident that we will continue to deliver growth in 2017. I would like now to turn the call over the operator for Q&A. Operator, please call for questions..
[Operator Instructions] The first question is from Justin Furby of William Blair. Please go ahead..
I guess maybe to start with Roni G, in terms of -- when we start to think about next year and the different puts and takes around growth.
Can you give us a sense as a lot of headwinds and moving pieces this year, when we look out to '18, what we should be thinking about, it sounds like APAC, the headwind start to go away, and I want to make sure I heard that right, but what about the retirement business and what about when you think about StoneRiver, and as your anniversary at next Q2, what kind of normalized growth rate do you think that will drive in the near term, and then I've got a couple of follow-ups? Thanks..
Hi, Justin. Thank you for the question. If we analyze the growth of Sapiens, we'd like to look at these as two angles, the Sapiens -- the original Sapiens and StoneRiver, we all the time maintain about 15% general organic growth quarter-over-quarter.
If we analyze this quarter on a constant currency basis without [indiscernible], our biggest customer and APAC, the solution we are talking about 14.5% organic growth. We expect to continue this growth at that level to next year.
StoneRiver, as we mentioned was a company those was in decline mode and our target this year was to stabilize this organization, we are on track of doing this and as we speak, we are investing -- increasing investment in sales and account management in order to build pipeline for next year.
We expect to start to grow with StoneRiver only in the second half of 2018. So if we do an analysis of these two trends on an overall basis, we're expecting to grow overall at the rate of 10%, but we'll provide guidance much more accurate at the beginning of 2018..
So 10% growth is what the reported growth and is the framework for next year, is that right?.
The framework, but we will give the guidance, accurate guidance into next year; that's the reason [ph]..
And then Roni Al-Dor, in terms of the P&C versus the life insurance market, P&C has been a bigger growth driver for you. Is that still the case, were there any changes that you noticed quarter-over-quarter in terms of the pipeline, and can you sort of talk to now that you've got through this investment on the ALIS business.
Are you seeing signs of success or incremental pipeline build from that? Thanks..
Yes. As you mentioned, our P&C demand is still very high, mainly in Europe, what we call rest of the world. We are seeing more customer, more prospect, it was very successful customer event, many potential customers also came. So we have a lot of visits in our sites, and the reference is very good. So the demand is high.
In terms of our life business is not as good as our P&C. We have few prospect. We are doing much better in the U.S. StoneRiver part. We did organizational change, we put a lot of effort, we hope to start to see the fruits of all of this investment in 2018..
And then on organizational changes, can you just walk through what happens to the people, the sales reps themselves, is there a lot of account transition and a lot of change next year, and do you expect that to be disruptive?.
Yes. We -- no, we did few organizational change. One, we brought a new manager for our decision business and one replacement for our life business, we add -- we promote from the company. We just open a new division for digital and we also build strategic product, strategic manager, that's more internal.
On the sales, we add more account manager, more sales, we replaced part of them. This is -- again, we start from the beginning of the year. So we will hope to start to see the fruits again in 2018..
And then maybe lastly, any update on the math mutual [ph] and what you look to do with that IP? Thanks..
We are -- as we mentioned, we decided not to put any investment after math mutual. So right now we have two alternatives to all-in, sometimes in the future to continue and to sell it or to find good buyer..
The next question is from Avishai Kantor of Cowen. Please go ahead..
So my first question again is on the demand environment.
So insurance clients are now probably in the process of finalizing their budgets for 2018; and I know you spoke about it a little bit, but can you speak maybe about specific top priorities investment areas for insurance -- for your clients and the breakdown between P&C and life for 2018, what you see right now?.
Yes. Everybody in the insurance now talking about the digital transformation, digital today to try to be more close to their customer. And this is very hot topic. In order to do it, they need to invest also on all the front end analytics and so that they need also to replace their back office system in order to support the digital.
So what we see in the market is two phase; one, to replace the consistent, but second to invest in all the digital area. In terms of life, we see more closed book opportunity run-off. There is less demand for life and we see more demand for the P&C carrier..
And then you mentioned 10% initial target for 2018 in terms of revenue growth.
What's the range between organic and non-organic? What's factored in that number?.
We are -- Avishai, this is Roni G; we are basically talking about organic growth..
I have one more follow-up question.
Any feedback from clients on all the organizational changes, which you have been doing in specific, some changes within sales, any initial feedback from clients?.
Initially it's very positive, both from our life and decision, as well as the account manager and everything around digital very happy that we build one digital, we put one investment for all of our product line. They wants to see us as a glue for all of it. We saw it also in the conference.
Everything around this strategy, we are putting a lot of investment with the analysts, we did it at the past, but right now, we improve and we are become more and more closer. We are doing a lot of Analysts Day of meeting and [indiscernible] with them; so a lot of activity around the sales and marketing as well. So the overall is positive..
[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 2 hours. In the U.S., please call 1888-295-2634. In Israel, please call 03-92-55927, and internationally, please call 972-392-55927.
Mr. Al-Dor, would you like to make your concluding statement..
Yes. Thank you for you, and thank you for all those who participated and joining us today. Have a good day..
Thank you. This concludes the Sapiens International Corporation third quarter 2017 results conference call. Thank you for your participation. You may go ahead and disconnect..