Clarivate Plc (CLVT) Earnings Call Transcript & Summary

Hi, everyone. Good morning. My name is Ryan Fenske. I'm the high-yield services research analyst here at BofA. Thank you for joining us this morning. I'm pleased to be hosting Clarivate. I'm joined by Chairman and CEO, Jerre Stead; and Chief Financial Officer, Richard Hanks. Thank you guys so much for joining. And with that, we'll get started.

So you guys have been working on your One Clarivate initiative for a few years now. You're expecting the strategy to be live starting January 1. Now what are the key changes and opportunities that investors should be focused on as we head out into 2022 and One Clarivate is rolled out?

Great question, Ryan. Let me just give a little history to get everybody up to point. It's only been 30 months since we went public. So we didn't start One Clarivate until January of this year, but I'll give you the background because it's a great question. When we took over with the reverse merger end of May 2019, we had 7 stand-alone businesses, was -- Clarivate was, which was the spin-off from Thompson. We announced in September that we were moving -- September 2019, we were moving to 2 groups: the IP Group and the Science Group, which we did. That was the first step of what we needed to accomplish. During that next 1.5 years, we did several things. One, made 2 major acquisitions that we had planned to do back before we even closed with Clarivate, taking it public. Also, we divested 3 businesses that didn't have the kind of growth potential from a revenue or an EBITDA standpoint. So we went through all that. We moved, as I said, from 7 groups -- 7 stand-alone businesses down to 2 groups. In January of this year, we announced to our company in a worldwide kickoff meeting that we would go to One Clarivate. One Clarivate was the big step that we plan to take, and I'll explain that in just a second. In January, we kicked off in Asia Pacific implementing that particular strategy. We were very pleased to have it done, and it went live July 1. So what it is, is very straightforward. This company has more potential -- I'm now on my 42nd year as CEO of public companies. And then as to potential that this one has, what we needed to do was move with a great set of products, highest customer delight I've ever seen to where we could sell solutions into 4 major markets, and that's where we're at today. That's already the goal. We'll kick off live January 1 of 2022. Feel very good about it. Feel better about the progress. But think about being able to take all the appropriate products outside in with solutions into those 4 global markets. We'll talk more about that, but they're large, very attractive markets for us. So that's where we're at, ready to go.

Great. How's your technology platform evolved over the past couple of years? What are the benefits that you're seeing as a result of the investments that you've made so far? And what level -- or what are the key areas of investment for you guys going forward? Where are you focused?

Yes. I'll start. Richard will pick up. Richard deserves a great deal of credit because when he arrived almost 5 years ago, there was no product pipeline, period. And in fact, I would say one of the great upsides for us was that it had been underinvested in. The platforms we're at today, and Richard will describe those in just a moment, give us the opportunity to provide our customers with perfect solutions for their internal needs as we build in our products and platforms into their work streams. Richard?

Yes. So Ryan, all of -- almost all of our technology is now cloud-based. What we have really focused on is moving from providing point solutions to clients to real interoperability across the platform capabilities that we have. So that's been a real focus for us in academic and government and life sciences and now increasingly in [ IP ] as well. I would also add that in terms of -- the core of Clarivate is content and data. There's been a complete re-architecting of our content ingestion capabilities, introduction of artificial intelligence and machine learning so we can scale that capability. But also, that re-architecting enabled us to share content sets and data sets across our products much more dexterously than we were able to previously. So that's been a really, really important deliverable for us. And then finally, we have now [indiscernible] of our products able to release application development at will. So the cycle times on new code and new functionality being released is much, much more rapid than it was previously. So significantly architecting and we're, as I said, substantially cloud-based.

And the only thing I'd add -- thanks, Richard. Perfect. Ryan, a couple of things. We are spending and we'll continue to spend about 5.5% of CapEx each year -- of revenue, sorry, in CapEx for new products. So you'll see that stream continue. We announced at end of Q3, we had introduced 60 new products or improvements in 2021 alone with many more to come in '22. But it's really fun to see the platforms that are in place that Richard described so well and where we take this next.

That's great. At your recent Investor Day, you guys laid out some pretty impressive customer retention expectations for 2022 and beyond. Could you remind us where you are now, where you expect to be over the next couple of years and what the key drivers are that are going to get you there?

Yes. I'll start. Richard will pick up. Critical question. What we said is we expect to move to 92% to 93% retention of annual subscription in 2022. We're at 91% this year. We've done a lot of cleanup. But most importantly is we now have full inside sales in place that carry about 24,000 of our customers; in other words, 80-plus percent of those. That's where we are and we'll continue to see significant improvement. It's pretty simple. What we've done now is shift to a point where our outside salespeople on average will carry about 16 accounts. They were carrying over 60 of these. So that's the big shift we put in place. Also, we put in place 3 centers of excellence worldwide that covers our inside sales and equally important, our customer service on a worldwide basis. I couldn't feel better about that. The results improved significantly in 2021. We announced actually at Investor Day that our customer delight was 78, up significantly in 2021. And most other companies were flat or down. So that felt really good. I couldn't have felt better about that. Richard?

So when we think about the categories of revenue at Clarivate, 55% of our revenues are subscription contracts. 25% are -- is associated with what we classify as reoccurring revenues, which is our patent and trademark renewal business. And then 20% is purely transactional. So as Jerre said, in the case of subscription contracts, 92% to 93% is our expectation for 2022. We consider best in class to be upwards of 95% retention rates. Some of our products, particularly in academic and government, are already exceeding that level. But we need all the boats to rise to all the product improvements we've made and of course, the migration to inside sales, which is such an important lever for us as we improve our market interface through that capability. So we need all the boats to rise to 95% through all of the apparatus that we put in place over the last 2 to 3 years. In the case of reoccurring revenue, that patent and trademark renewal business, our customer retention rates are over 99%. So we have extremely sticky capabilities in that space. But in the case of subscription revenues, as we've said, Ryan, we're measuring revenue retention rate there pre price, pre upgrade. So it's a very clean, very pure measure.

Great. And 2 quick follow-ups. One, Richard, the breakout that you just provided, is that for the -- just for stand-alone Clarivate or is that pro forma with ProQuest included? And then how are you guys monitoring progress on retention kind of ahead of renewals early next year? I know the beginning of the calendar year is a big time for you guys there.

Yes. That's a great question. So those numbers are existing Clarivate excluding the ProQuest transaction, which we hope to complete in this quarter, of course. And ProQuest has a significant corpus of revenue associated with subscription agreements. So the weighting would improve in favor of annual recurring revenue once we complete that transaction. And as to your point, as we are -- we are obviously monitoring renewals going into 2022 now because we're obviously in negotiations with clients who have Q1 renewal dates. 50% of the book, the legacy Clarivate, renews in the first quarter. So as I said, we're very confident that we will achieve that 92% to 93% retention rate on a full year basis next year.

Okay. Great. Maybe we shift over towards M&A. When you guys look at your pipeline, are there any areas of the business that you're particularly focused on? And then can you also talk a little bit about how the One Clarivate initiative is changing the way that you think about M&A opportunities going forward?

Yes. I'll start. Richard will pick up. Several things. We continue to do tuck-ins and we will. You -- our investors should think about us doing 4 to 6 a year. Those are very high -- accretive or we wouldn't do them. A couple of reminders. We don't do auctions. What we do is -- what I've always said is we want to be the preferred acquirer, and that's critical for us, patient, persistent, preferred. So we see those. They're good. We'll continue to do those with very, very high incremental margins and revenue growth is equal to or above the targets that we've had. Larger ones we'll look at is -- we introduced those 4 global markets that are a very important part of the way our sales force is organized as of January 1. Those do open up other potential markets for us. We'll look at those as we move forward. And most important to us, again, we do not participate in auctions. With the larger ones, 2 rules of the road for us, always has been. We must have during the first year of the acquisition at least 10% all-in accretive adjusted EPS for the entire company with the larger ones and 15% or better in the second year. If you look at the guidance we gave at the -- including ProQuest, if you look at the guidance we gave on Investor Day, you'll see there's almost a 30% increase in adjusted EPS 2022 over 2021. So that's critical. And then the other side of the coin, and Richard, just talk about that a bit, if you would, please, is the debt we'll carry is part of the -- what we have to accomplish with large acquisitions. Richard?

Yes. I mean this -- you may cover this later, Ryan, but we've stated rather consistently that our net debt leverage targets are in the low 3s and that we would be prepared to increase leverage into the 4s, as we've done with CPA Global, for example, which is a major transformational acquisition for us. So that's the sort of the boundaries that we are operating within, burst up into the 4s for a transformational transaction and then, of course, using our high levels of adjusted free cash flow to bring leverage down into the 3s over a quick period of time. And so when we look at 2022 and the guidance we gave at Investor Day, leveraged free cash flow of between $700 million and $750 million, that will get us into the 3s during 2022 once we've completed the ProQuest transaction. In the case of M&A, when we think about the 4 customer segments for One Clarivate, once we complete the ProQuest transaction, we'll have real scale in academic and government. If we think about the combined business being approximately $3 billion in total revenue, $1.3 billion plus of that will be in the academic and government segment. So we've got some really attractive end-to-end capability serving our clients in that space. Life sciences and health care is a very attractive set of end markets for Clarivate. We remain very focused on that space. And then as we come across into consumer products, manufacturing and technology, gaining greater scale there and eventually going from 4 segments to 5 would be an ambition of the company as well.

Okay. Great. Kind of post ProQuest, you'll have completed 3 larger acquisitions. You guys just talked about the tuck-in strategy. But kind of what are your thoughts on another larger acquisition in the near term? Is there any appetite for that? Or are you guys going to kind of press pause on those for a little while and focus on integrating ProQuest and CPA and DRG?

So -- no, that's a great question. CPA integration is, for all practical purposes, done. Very proud of the team that did everything. And of course, we lapped the close of that on October 1 of this year. So that's in great shape. It's important -- now let me just step back for a minute. We had our eyes on DRG and CPA when we actually did the reverse merger. In fact, with DRG, we worked on that starting 3 months after we went public, and we closed on February 29 in 2020. Interestingly enough, we ended up shutting down our company from working in the office to working in home 2 weeks later. So just couldn't have been more pleased. We then had our eyes, as I said, on CPA. I actually met with the owners, Leonard Green & Partners, in February of 2020. We worked through that and closed, as I've said, in October of last year. We always -- look, just so you know, I looked at those 2 all the way back in 2012 when I was leading IHS and we were looking at acquiring the Clarivate piece. So we knew those, looked at them, saw what they can do for us and us for them. I always had looked, including back in 2016, hard at ProQuest. Huge respect for what they were doing, 51-year-old private company, amazing, amazing results. I had hoped, I guess is the way I'd say it, that we would do that acquisition in 2022. We've made a decision very much with the Snyder family to bring that forward. Couldn't be happier we did it. The family kind of had a decision to make, which was take it public or do what we reached agreement on. So that was sooner than we expected, and I couldn't feel better about it. We'll spend 2022 getting all the consolidation done, getting all the integration done. So that will keep us more than occupied with large ones in 2022 and in early 2023. In the meantime, to your point, we will do more tuck-ins that are, as I said, highly accretive. And we will look, as we said, at the 4 global markets Richard described so well to see if there are things with larger acquisitions that will complement down the road.

Great. And then one more on the M&A topic. You guys have done a really great job of managing M&A-driven fluctuations in leverage through prudent equity issuance over the last couple of years. Can you talk about your framework for debt versus equity funding when you're looking at a potential acquisition? Richard, you kind of mentioned the kind of willingness to go up into 4s and then down into the 3s. But maybe just kind of touch on that equity component a little bit.

You start, Richard. Great question.

Yes. As Jerre mentioned, for transformational acquisitions, the guar drails we operate within when we're using equity is to ensure that we have a double-digit EPS accretion after 12 months on a run rate basis and then, of course, into the mid-teens after 18 months, 2 years. So that's the metric that we apply. In the case of the debt markets, obviously, they're highly liquid currently, and so we've tapped those. Obviously, we entered into a secured and unsecured set of notes as we raised capital in June for the ProQuest transaction. And so we are very attracted to the debt markets currently, but of course, always, always operating within the leverage ratios that we've consistently applied over the last 3 years since we've been a public company. As I said, low 3s is where we expect to operate on a steady-state equilibrium basis and going up into the 4s with the right transaction. So those are the parameters we apply.

And what I'd add to that is, as Richard said earlier, we now have the scale we wanted. Before debt payments, we're now $1 billion free cash flow. It's a wonderful business, so strong, very tax efficient. So that gives us the flexibility to make the best decision for shareowners where we match out the trailing debt ratio, we match out the overhang of the companies like Leonard Green and others and acquisitions. And we will make a combination of those that meet the goals Richard just talked about and give the best return to shareowners. But having $1 billion capability, and of course, that's going to grow significantly each year, makes us able to be very flexible as we move forward. Great question.

Great. And then sticking with the leverage theme. You guys talked about getting into the 3x next year, and you have the 3.5x net leverage target for 2022 as well as at Investor Day, you talked about 3x over the medium term. Can you just kind of frame what you guys are thinking when you talk about the medium term in this context? And then relative to other capital allocation priorities, how important is it to you guys to hit these targets?

That's great. Richard?

Yes. So medium term for us would be getting into the low 3s 2023. And the reason why I say that is that 2022 is a year of integration for the company as we absorb ProQuest and execute that transaction. And so we will be obviously in the 3s during the course of 2022 but getting to the low 3s in 2023. So that's our objective. Obviously, we've got to expend dollars on [Audio Gap] so important. We've got our own repeatable playbook in terms of managing these large transactions. This will be -- ProQuest will be the third transaction in approximately 2 years -- a little under 2 years actually as we completed the DRG transaction in February of 2020, the CPA transaction in October. I'm hopeful to complete the ProQuest transaction, of course, in this quarter. So in under 3 -- under 2 years, we've completed 3 transformational deals. We've executed those integrations extremely well. The cost-saving goals that we set for both DRG and CPA were exceeded, both in terms of quantum and timing. And we've obviously set the cost-saving targets and given that guidance to the market for the ProQuest transaction as well. So we'll be working extremely diligently in 2022 to integrate that acquisition and to get the synergistic benefits both in earnings and cash flow back to our investors.

Great. And that kind of leads right into my next question. Like as you said, the integration efforts and the cost saves that you guys have achieved over the last few years have been pretty impressive. Can you just talk about the playbook broadly? And then you also recently mentioned an additional $35 million to $40 million of internal savings that you guys were working on. Can you provide some color on where those are coming from?

Yes. You start, Richard. I'll wrap up because it's -- I'm very, very proud of what everybody has accomplished and just given the facts as our friends and where we expect to be when we exit 2022.

Sure. So -- and we have real scale now in best cost locations which serve a number of our functional areas: technology, content in particular. And so it's leveraging those scaled platform capabilities where a lot of our synergies now come from. In the case of the project management office, obviously, we've got an experienced team now that both organizationally and from a systems and process perspective are able to concentrate and focus and provide the metrics that we require each week to understand the direction of travel as we complete these integrations. So that's working extremely well. In the case of the incremental savings that you've referenced, that is principally from the One Clarivate organizational simplification. We started that process July 1 in Asia, where we move to that customer segment model. And obviously, we're rolling that structure out into the rest of Clarivate with effect from the 1st of January, so all will be in place January 1. And so it's some of the simplification of the matrix which is enabling us to deliver additional savings that you referenced, Ryan.

If you think about it, we've -- this company will operate in the high 40s, low 50s in adjusted EBITDA margins. We're right on track for that. Couldn't be prouder of everything we've done. And it's way north of 3 -- when we exit 2022, it's way north of $320 million, $330 million of savings from the time we started in June of 2019. So very proud of everybody. And it's -- I think it's important to know this is never ending. Every company I've led over the years, we continue to expect, through technology and training and development, to increase productivity. As Richard said, he's led this, he's done a great job of best cost locations. So there's a lot more that we'll continue to accomplish, but I'm very proud of what we've accomplished at this point. And as I said, we should be thinking about and certainly are thinking about high 40s, low 50s on EBITDA margin. The wonderful thing about that is because of our tax efficiency, we're able to generate about 80% free cash flow before debt payments.

Great. How are you guys thinking about your credit rating over the next few years as well as on a longer-term basis? Do you have any investment-grade aspiration? Is there a level within high yield that you're targeting? And then any conversations of interest as of late with the rating agencies?

Great question. Richard?

Yes. I mean high single, low BB is our stated policy. We're not focused on investment grade at this stage. I think that we're very, very comfortable in terms of our current rating levels and probably moving us up a notch as we complete the -- obviously complete the ProQuest transaction and then integrate that business into the Clarivate structure next year. In terms of your reference to the rating agencies, as we obviously raised capital to fund the ProQuest transaction, they were focused on pro forma organic revenue growth, our cost-saving goals, our margin goals, which we've done extremely well with, and then, of course, free cash flow. So those are the standard metrics they looked at, and there was nothing unusual out of the conversations we obviously have.

Okay. Great. Yes. We're just about out of time, but I just want to give you guys an opportunity. Is there anything else that you'd like to comment on or highlight before we wrap up?

I'd just add 2 things. One, I'm very proud of what we've accomplished, and it's been fun to partner with Richard and the rest of the team as we've done this. It's important to know, in 2018, we were -- if you take out the divestitures, we were $830 million of revenue and a little over 25% EBITDA, 26%. As we go in with the guidance we've given for 2022, it's approximately $3 billion. And we've done that with amazing results and with much more to come. I had set that target, my own personal target, of $3 billion in 2021 to hopefully accomplish it as we exited 2022 into 2023. We're ahead of that schedule. And now as Richard said so well, the scale we've got, the next target, personal target, will be to double that business and therefore, the return and cash per share in the next 3 to 4 years. So really proud of the team. Thanks, Ryan.

Great. Thank you so much, Jerre and Richard, for the time. I really appreciate you joining us today. Thank you.

Us too.