Sapiens International Corporation N.V. (SPNS) Q1 2023 Earnings Call Transcript
Welcome to Sapiens Corporation’s 2023 First Quarter Financial Results Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded May 3, 2023.
It is now my pleasure to introduce your host, Yaffa Cohen-Ifrah, Chief Marketing Officer and Head of Investor Relations. Thank you. Yaffa, you may now begin.
Thank you, operator. I would like to welcome all of you to the Sapiens conference call to review our first-quarter results for 2023. With me on the call today are Mr. Roni Al-Dor, President and CEO; Mr. Roni Giladi, CFO; and Mr. Alex Zukerman, Chief Strategy Officer.
Following the summary of the results, we will all be available to answer any questions. Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements. The safe harbor provision in the press release issued today also applies 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. On today’s call, we will refer to the non-GAAP financial measures.
A reconciliation of GAAP to non-GAAP results has been provided in our press release issued before the market opened this morning. A replay of this call will be available after the call on our Investor Relations section of the company website or via the website link, which is available in the earnings release we published today. I will turn the call over to Roni Al-Dor, President and CEO of Sapiens. Roni?
Thank you, Yaffa, and thank you to everyone who has joined us today. I want to welcome you to our earnings call. Sapiens had a solid first quarter with a 6% year-over-year increase in revenue to $124.8 million. Our hard work of dedication has paid off as we also delivered a higher operating profit of $22.5 million, resulting in an operating margin of 18%. We are excited to continue this positive momentum throughout the year and achieve continued success.
Our customer-centric model implemented globally has consistently driven growth and profitability while generating cash flow. Sapiens has an established track record of growth, profitability, and high cash generation. North America is returning to growth. I’m happy to share that our hard work and extensive groundwork in North America are paying off. Thanks to the dedication of our team and my oversight. We’re excited 2022 is improving, and the good news is that the momentum is continuing into 2023. We are excited to see what we can achieve this year with this positive energy and drive.
In North America, Sapiens is serving the life and annuities market and the P&C market, which include workers’ compensation and reinsurance solutions. Since the beginning of 2023, we have signed new P&C deals across all of our P&C products, core P&C, workers’ compensations, and reinsurance markets. Our specialization in offering differentiated P&C products, the target niche markets with high growth potential, creates Sapiens a party North America market. As a result, we are making excellent progress in building our pipeline and developing new opportunities of all of our P&C products.
Our success in workers’ compensation is driven by our leading core suite for workers’ competition solution, which Aetna and Protecta recently recognized as an established player for property and casualty policy administration systems in North America. Our product is designed exclusively for our workers’ compensation line of business. This gives us domain expertise and an excellent referenceable client base. Since the beginning of the year, we have signed new workers’ compensation deals and are progressing with additional deals.
After 2 years of slowdown in the pace, mainly due to COVID, the worker’s competition market represents a significant opportunity for Sapiens in North America and Canada this year and in the coming years. Our core suite for P&C products has been a bright spot for us in North America. Thanks to our significant investments over the past 2 years. During this time, we strengthened our foundation, enhanced our cloud offering, and provided stability for our existing customers. After a brief pause, we resumed our outreach and pipeline-building efforts, which have led to new success and widespread product selection. In fact, we signed a new cost-for-PNC deal in the first quarter and are progressing with our additional deal, underscoring the strength and appeal of our product.
Our North America Life and Annuity business continued building momentum in core suite and business application offering for life. We secured another core-site deal in the first quarter, demonstrating the continued demand for our products. While we are not disclosing specific detail about this particular win, we are exciting to have reestablished our position in this life market. Additionally, we are seeing strong traction in our business application for life with new deals signed and existing customers upgrading to the latest version of our software. Following our recent re-architecture effort, this is a proof to the quality and the value of our products, and we are committed to continuing to innovate and improve our offering to meet the market’s evolving needs.
We have achieved a high win rate in life, reflecting the quality and the value of our products and services. Since the beginning of the year, we have grown our North America sales and marketing and customer success team to support our future growth. As we continue to refine our sales and marketing plans and leverage our industry expertise, we are confident that we will further improve our closure rate in this market. With a dedicated team and a customer-centric approach, we are committed to delivering exceptional solutions and exceeding our client expectations.
Switching to Europe. This market remains our highest growth region. Several positive dynamics contribute to the first quarter’s high single-digit growth with experience in the region. First, we see increased demand for system replacement in life and pension. Organizations are coming back to the market, looking for core system replacement and as a result, we have a lot of activity in the life pensions. Second, we also see increasing demand for P&C and digital solutions in the market. And the third element that contribute to growing Europe is the increasing acceptance of the cloud. European insurers are embracing cloud solutions, and we have more customers open to the cloud solutions.
I want to highlight our strategic focus in Germany. The German insurance industry is one of the largest in the world, with a total premium exceeding EUR 220 billion annually. This represents a significant growth opportunity for Sapiens, and we are well-positioned to capitalize on it by offering our core digital and reinsurance solutions. Since acquiring sum.cumo in 2020, we have invested significantly and established a strong local presence in the German market. Our efforts have focused on expanding our P&C and digital products and increasing our sales and support team in the region. These investments are paying off, and we are seeing positive momentum in the market. We see opportunity for IDITSuite and skip solutions, with a top-tier German insurance player. In addition, the opportunity to develop this market for additional Sapiens products like reinsurance and digital and in the future with the life and annuity solutions.
The EMEA region continued growing across operating casualty and life and pension. Our results reflect our consistent progress in these regions. Recognition from the leading industry analysts support our sales team effort and provide excellent reference. In early March, we announced the 7th victory for P&C won Celent’s 2023 XCelent Award for the Breadth of Functionality category in the EMEA region. The product was named as a luminary solution, the top tier in XCelent technical capability magic. It is the only non-U.S.-based solution, giving this award. IDITSuite is clearly positioned a leading platform in EMEA. The luminary classification was also given to Sapiens IDITSuite in the APAC region. XCelent also highlighted 2 other segment solutions. Sapiens TI policy solution was named a functionality and standout both in EMEA and LATAM region, and Sapiens was named as a notable solution.
Switching now to Sapiens’ cloud and digital progress. Digital is a dynamic domain, and we are building our South digital proposition, tightly connected, yet closely coupled, recipient core solution that’s enabling our clients to benefit from the complete tapes proposition while maintaining their freedom of choice. In order to achieve success in this segment of our business, we have established several key priorities for 2023. Our top priority is to provide a persona-based package for agents and for customers on top of each one of our core products, life, and P&C. The personal package is a high focus on usability, U.S., and also smart features and ends by artificial intelligence and mature learning to enable easier work and easier decision-making. We plan to support more out-of-the-box machine learning modules in our portals, offer a dynamic questionnaire solution recipients’ decision, and integrate with Data Hub as a real-time data consolidation layer.
We also plan to offer pre-integration with data enrichment providers, which will help us deliver even more value to our customers. Another key element in our approach is enabling a swift time to market with local tools and the concept of smart components, smart components introduce. Out-of-the-book features and components integrated with the core and data platform enable changes and the ability to add capabilities to each persona for rapid time to market. It enables groups to create their own repository to share between the implementation across the organization.
Sales management is another critical area of focus for us. And we plan to introduce the first phase of our [indiscernible] management system. We will also introduce company-level setting in the journey for composer and offer multiple workspace and easy mapping in the API composition engine, making it easier for our customers to manage their operations and improve efficiency.
Finally, we are committed to extending our touch points with end users to improve our connection and provide greater value. This includes integration with leading platforms such as MSDynamic, MS Office, GLIA, SPLICE, and more, which will help us provide a more seamless experience for our customers. This was a busy quarter on the marketing and brand awareness front, Sapiens team exhibited in the indices reshow worldwide in Spain, Germany, and the U.K. and U.S., and we are increasing our investment in Sapiens brands and our solution with digital activities and campaigns. In addition, we are preparing to host our annual international trans conference in Barcelona later in May and our North America Customer Summit in Arizona in October.
Looking ahead to the remainder of 2023, our key objectives are, first and foremost, growing our presence in North America market. This will involve investing in our sales and marketing efforts, building relationships with key partners, and maintaining investment in our innovating solutions that meet the evolving needs of our customers. In addition to expanding our presence in North America, we are also focused on deepening our relationship with our existing customers and growing in every territory we operate. We will also look for opportunities to upsell and cross-sell an essential advantage of our long-term sticky customer relationship. In parallel, we have the solution to address their digitalization and cloud needs.
Another key objective is expanding beyond our core offering into digital, data, and analytics as we recognize the tremendous growth potential in these areas. Finally, continuing our transition to the cloud will enable us to deliver our solution more quickly and efficiently, provide greater scalability and flexibility for our clients and enhance our overall competitiveness in the market. By focusing on these key goals, we are confident that we will continue to drive the success and growth of our company and deliver exceptional value to our clients.
Our continuous investment in products and solutions has earned industry recognition enhancing our standing in the global insurance market. As the CEO of Sapiens, I am proud to lead a team deeply committed to executing our strategic plan and delivering sustainable growth and value for our shareholders.
Now I would like to turn the call to Roni Giladi, our CFO.
Thank you, Roni. I will begin my commentary with a review of the first quarter 2023 non-GAAP results, followed by comments on the balance sheet and cash flow. I will wrap up with our updated guidance for 2023. Revenue in the first quarter of 2023 was $124.8 million, an increase of 6% compared to $117.7 million in the first quarter of 2022. Revenue in North America was $50.4 million compared to $49 million in the year-ago quarter, an increase of 2.8% or $1.4 million. We feel confident that the revenue in North America will continue to grow in the coming quarters.
Revenue in Europe was $64.6 million, a year-over-year increase of 9% from $59.3 million. And revenue in the rest of old, which includes South Africa and APAC, increased 4.1% compared to the prior-year quarter, reaching $9.8 million. Gross profit increased in Q1 2023 by $3.4 million, totaling $66.4 million, while gross margin increased by 20 basis points to 45.2%. Operating expenses increased $1.7 million year-over-year to $33.8 million. R&D spending increased by $1.4 million, representing 13.8% of total revenue compared to 13.5% last year. The increase in R&D reflects our continued investment in cloud solutions.
SG&A expenses remained at the same dollar level and were reduced to 13.3% of total revenue. Operating profit and margin in the first quarter of 2023 were $22.5 million, an increase of $1.7 million compared to last year. Operating margin increased by 40 basis points to 18%. During the quarter, we reached 51% offshore ratio growing from 47.2% in the first quarter of last year, which supports our activities and profitability. Financial expenses this quarter totaled $1.2 million compared to financial income of $348,000 in Q1 of 2022, reflecting the impact of currency hedging on the British pound, euro, and Israeli shekel.
EPS was $0.31 per diluted share for the first quarter of 2023, similar to Q1 of 2022, reflecting the improvement in operating profit, which offset by the negative impact of increased financial expenses due to currency hedging. EBITDA increased by 7.6% to $23.6 million in 2023. EBITDA margin in Q1 2023 was 18.9% compared to 18.6% of last year.
Turning to our balance sheet. As of March 31, 2023, with cash and cash equivalents and short-term deposits totaling $182 million and a debenture of $60 million, the cash position at the end of Q1 reflects a $20 million debenture principle we paid at the beginning of 2023. The remaining $60 million will be paid in prequal installments over 3 years.
Turning to our adjusted free cash flow. During Q1 2023, we generated adjusted free cash flow of $19.9 million. The improvement in adjusted free cash flow resulting from the collection of delayed payments from 2022 and progress in ongoing collection processes. During the quarter, we declared a cash dividend of $13.8 million or $0.25 per share for the second half of 2022. The dividend was paid to our shareholders on April 24. Our cash position, positive cash flow, and dividend distribution reflects our solid financial performance and position and our ability to execute our strategy, even during a challenging macroeconomic situation.
This quarter, we provided an additional view of our revenue gross margin to help our investors better understand the revenue buildup, predictability, and profitability. We split our revenue into 2 groups and provide period-over-period comparison as such, a new period is reported. The 2 groups are: one, software products and re-occurring post-production services, and two, reproduction implementation services. Software products and re-occurring post-production services include mainly term license, maintenance, cloud solutions, subscriptions, and post-production services. The revenue stream is a mix of recurring and re-occurring in nature.
Pre-production implementation services include mainly implementation services before go-live, which are one-time in nature. In Q1 2023, revenue from recurring software products and re-occurring post-production services totaled $81.8 million, representing 66% of total revenue compared to $75.6 million and 64% of total revenue in Q1 of 2022, an increase of 8.2%. The gross margin for Q1 2023 was 54.8% compared to 53.5% of last year. Revenue from pre-production implementation services totaled $42.9 million, representing 34% of total revenue compared to $42.1 million and 36% of total revenue of last year.
The gross margin for this group this quarter totaled 26.8% compared to 29.7% last year. To summarize, our software product and re-occurring post-production services are significant and valid, representing 2/3 of Sapiens revenue with a gross margin of 55%, significantly higher than our preproduction implementation services margin and higher than our blended reported gross margin. I want to turn now to our guidance for 2023.
We are increasing our full-year 2020 non-GAAP revenues to a range of $507 million to $512 million compared to previous guidance of $502 million to $507 million, reflecting an organic growth rate of 7.3%. We expect our North America region to continue to build momentum that will translate to revenue growth in the coming quarters. We are also increasing the guidance for the full year 2023 non-GAAP operating margin to a range of 17.8% to 18.2% compared to a previous guidance of a range 17.6% to 18%.
We continue to improve our offshore ratio while implementing efficiency steps in our division and corporate while continuing our investments in our products. To summarize, Q1 2023 was a strong quarter for Sapiens. Revenue, gross profit, and operating profit improved compared to last year. Our balance sheet and cash generation are solid. We remain committed to our focus on driving growth and profitability.
I will now turn the call back to Roni Al-Dor. Roni?
Thank you, Roni. As we move forward, we remain committed to executing our strategy, leveraging our strengths, and delivering sustainable growth and value for our shareholders. I would like to thank our clients and shareholders for their continued support and trust, and we look forward to delivering even greater success in the years to come. Operator, we are ready to open the call for Q&A.
Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Kevin Kumar of Goldman Sachs.
I wanted to ask about Europe and strengthening the region this quarter. Roni, you called out strength in my contention, but curious how did P&C perform in Europe relative to your expectations? And then any regions in Europe that you would call out that had a really strong performance in the quarter.
Yes, I would like to start, Kevin, and then Roni can follow with the product. This quarter, we grew about 9% year-over-year on the European market. We see the growth coming from the German market, the U.K., and the Nordics. This is across Europe. We also see in the quarter that we have some catch-up revenue from the previous year, so the 9% is on the high, but we expect to grow in this region at the level of high single digits during 2023. Overall, it looks promising and good, and will continue that.
That’s helpful. And then I had a question on the new gross margin disclosure. I believe the software and postproduction services gross margin improved year-over-year by over 100 basis points. So just curious about the moving pieces there that’s driving the increase in the gross margin.
Yes. On the gross margin, on the blended rate, we see a slight increase from 45% to 45.2%. The improvement is coming from several factors, obviously, increasing our highly quality revenue, which includes revenue from subscription, term license, and managed services, and cloud solution. This is number one. The second thing, we increased the offshore ratio in the company. If we look quarter-over-quarter, we went from 47% in Q1 of 2022 to 51% in Q1 of 2023. So this is another factor and some upside there coming from P&C. So overall improvement on that.
If we look at the breakdown that we provided this quarter, breaking this to 2 groups, which is the recurring and re-occurring versus the onetime, we’ll see also improvement on the gross margin coming from Group A, which is the high-quality revenue.
The next question is from Mayank Tandon of Needham & Company.
This is actually Kyle Peterson on for Mayank. I wanted to touch on the quarter, particularly revenue in Europe. It sounds like there might have been some one-time kind of revenue that you guys kind of talked about. But I guess, could you quantify whether there was any one-time nonrecurring revenue or anything of note in that 1Q upside?
No. The revenue in European in Q1 was some catch-up coming from the signature of contracts and some of the milestone percentage of completion. This is the catch up. This is not a one-time, which is recurring by nature, the overall growth in this region by the end of the year should be the low-high — sorry, high single digits.
Okay. That’s helpful. And maybe just a follow-up, particularly on the quarterly cadence of the year in terms of the growth rate. Should we be thinking of something reasonably linear? Or should the growth rate be a little more maculated given in the macro? Or, I guess, how should we think about the progression of ’23 relative to guidance?
I think we’ll see step by step the company is closing new logos, adding additional layer of revenue for the company. So we see step-by-step growing revenue quarter-over-quarter until the end of the year.
The next question is from Dylan Becker of William Blair.
Maybe starting on the North America side. I know there’s been a lot of restructuring over the past several quarters. So it seems like you’re really kind of starting to strive here. Can you talk about some of those efforts, maybe how the pipeline is progressing and how that gives you kind of visibility and coverage throughout the remainder of the year and how this is framed into that kind of revised outlook that maybe implies maybe further strength throughout the net of the year as well?
Yes. So about the investment that we are doing, I would like to start with the business development and sales marketing, partnering ecosystem, all of this — as we — Yaffa rejoined us again. So she’s building together with the team, all the marketing activity. We put more effort on the SDL. Right now, because of COVID, we are going to many events. We are continuing to build the relationship. We analyzed together with Alex. So this is in the marketing. On sales, Gary rejoined us and is now building the team for the — what we call CCs, the account management. As all of you know, we have many, many accounts in North America that we can — we believe that we can add more and more solutions for them like the cloud services like digital data and any kind of cost-sell opportunity. And then we also invest — we increased the sales reorganization.
So overall, we are still in this process, by the way, next week. We have, a week after next, we have a big sales kickoff. Many new mid people join us from a different area. So that’s the investment. We believe that we can really see the fruits in the end of the year and the building pipeline for next year. So that’s about the investment. About the product suite, again, I don’t want to repeat, but the main focus right now is our 2 life core systems that we have, life and P&C. In the same time, we are continuing to put a lot of effort in our reinsurance, the component decision management, and the unique solution that we have for the workers form that we have a really good pipeline. We also mentioned we closed deals. We are selected in another one. So we had a lot of activities in this year as well.
Got it. That’s super helpful. Appreciate the color there. Maybe and you’re kind of trending is Roni on the margin front, see the nice progression as well. I appreciate the color and breakdown. How should we think about sort of the mixed benefits, software contributing to the gross margin? You’ve got the offshore-oriented, but you’ve also got probably future productivity coming from those sales reps that Roni was just talking about as well. It seems like maybe the software and the productivity could be more material drivers in the coming quarters here tied to that traction cross-sell motion. So wondering how should we think about kind of the east of the levers from a margin perspective as well.
Yes, we need to see progression on the gross margin, especially in the Group A, which includes the product revenue and the post-production services. But I would like to emphasize that this impact will be moderate and over several years. It’s not a onetime bank. We are investing, and we are making sure that our customers are satisfied. So we see progression, but moderate quarter-over-quarter.
Okay. Got it. And maybe one last one, if I could, to going back to Roni A. You mentioned the data and digital piece too. To understand kind of maybe a complex macro sales environment as well for heavier kind of core systems in nature, maybe. But how do you think about those digital and data capabilities serving as a wedge helping kind of accelerate maybe some nickel modernization efforts and maybe leading to a future cross-sell of more kind of core components going forward as well?
This is Alex here. So we’re definitely spot on. We see it as a strong potential to contribute in a couple of areas. First, we see that the wallet share of our deal is increasing because of the fact that we are providing in many deals, they not only our, let’s say, well-known core solutions, but also the digital platform on top of the data or both of them with cloud services. So a typical deal today for us includes more than one component. And this is one aspect to refer to what you asked.
The second one is we definitely see customers that are tending to start their digitalization journey, which can be a major journey through, first of all, dealing with the customer engagement problem, which moves a digital component, the portal web journeys, et cetera, to unlock their capabilities of working with their end consumers or agents and then go to core replacement. So also there, this allows us to insert ourselves into the customer environment to put a feet in the door to start, and then based on a good performance, we can continue to do larger projects on the core. And vice versa. We can start a project on the core. But when the customer sees our data capabilities, for example, and through the sales process, we suddenly see an increase and more interest in those components as well. So it acts both as an increase to the value of a deal and as a starting point that can lead to additional deals.
The next question is from Chris Reimer of Barclays.
Most of what I wanted to ask has already been addressed, but I wanted to touch on the reorganization in the U.S. and the improvement in the execution setup that you mentioned you had there. Do you think that that kind of reorganization is necessary in any of your other geographies? And then just touching on the offshore ratio. Are you reaching an inflection point? Just how well positioned do you feel with your total headcount right now and how you’re positioned going forward?
This is Roni Al-Dor. I will take the first call and Roni Giladi can take the second one. So in terms of the investment, as I shared with you 2 things on the U.S. investment, one, sales and marketing. We don’t need to do any reorganization in Europe because this is — we are — in the last few years, we build it. Last previous year, we put much more effort in Germany and Spain. And right now, it’s more or less stable. So that’s about the sales and marketing about. So I think that’s mainly what I can say.
Yes. Thank you. On the offshore ratio, over the last 12 months, we go from 47% to 51% as we stand for Q1 2023. We in the management think that over a few years, we can reach the level of 60%. This is something that we saw in other companies in the market. We feel it’s doable to provide our products and services with high quality. So this is the target for the midterm that we have. We are growing our offshore over the quarter. The attrition rate is obviously globally went down. So this may delay the increase in the offshore. But obviously, every quarter, we’d like to step up on those ratios.
I would like to add the one point, if I just missed it is just to explain for everybody about the main reason that we are doing this investment in sales and marketing at this moment is because we decided a year ago to bring back our core suite life to the U.S. So as all of you remember, we in the last many years, we have invested in our products. We’re growing very nicely in Europe, but we decided this is a good time to enter back to the U.S., and we also show the results. That’s one.
The second one is the core suite, P&C. We have some delivery challenges in R&D, as we mentioned a few times in the previous call that right now, it’s much more stable. I think we have an excellent product to offer to the market. So as we are feeling comfortable with our offering and we have much more reference, this is the right time to increase the sales and marketing. So those are the 2 main areas, the 2 core solutions, P&C NICE.
[Operator Instructions] The next question is from Surinder Thind of Jefferies.
My question pertains to Apex. You used to previously provide FX disclosures, but those were removed this quarter. Any color there on that decision? Endeavor constant currency growth rates.
Yes. Surinder, this is Roni G. If we look at this quarter, the effects on the revenue level was a headwind for us. Without this, the company will grow even faster than this, a few points better. On the profitability level, it’s the opposite. The currency, especially the shekel, was a tailwind for us and supported our improvement in the operation margin. The currency on the global basis, I know there was a lot of fluctuation. So we gave the guidance based on last week’s currency going forward. So this is for the full year.
Got it. And then if I remember correctly, your guidance assumed a minus 0.5% FX headwind. Is that still true at this point or you updated that?
No, no. We are providing guidance based on the last week based on the result of the business results and the last week’s cases.
Correct. I guess what is the expectation for the updated FX headwind? Or is it now staying still?
Can you repeat, please?
So for your revenue guidance, what is the assumed FX impact at this point? When you use guidance last quarter, the assumption was that FX would be minus 0.5% headwind. Is that still true?
No, no, no. Currently, we can’t see the tailwind continuing going forward, if I’m looking at the remainder of the year. So we have upside or tailwind from currency going forward. Again, it can change, but currently creating a tailwind.
There are no further questions at this time. Before I ask Ms. Yaffa Cohen-Ifrah to go ahead with her 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 1 (888) 269-0005. In Israel, please call (03) 9255-938. And internationally, please call (972) 3-9255-938. Yaffa, would you like to make your concluding statement?
Yes. Thank you, Joni. Thank you for joining the call today. We look forward to speaking with you again on our next earnings call. Please note that we are hosting a virtual one-on-one move with the Needham Technology and Media Contracts on Thursday, May 18. We’re also attending the Jeffrey Software Conference in California on May 31 and June 1 and the William Blair Growth Conference in Chicago on June 7 and 8. We hope to see you at one of these upcoming events. And thank you again for joining the call. Operator?
Thank you. This concludes the Sapiens International Corporation First Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.