Consensus Cloud Solutions, Inc. (CCSI) Earnings Call Transcript & Summary

Good afternoon, everyone, welcome back. Thanks for joining us. My name is Rishi Jaluria. I cover software here at RBC. I'm delighted to have with me the full team here at Consensus. We've got Scott Turicchi, the CEO; we've got John Nebergall, the COO; and Adam Baron, the SVP of Finance. Scott and John, Adam, thank you so much for joining us today.

Thanks for having us, absolutely.

Great. Wonderful. And for investors on the line, if you have any questions for the team, please do submit them through the box or feel pretty e-mail me directly, [email protected]. With that, I want to start at high level, right? So a newly public company with the spin-off from what was known as J2 Global, now it's Ziff Davis. In many ways, it's kind of full circle, right? The origin of J2 Global was jfax/efax, and now Consensus is effectively that business, plus, obviously, a lot more. But maybe speak a little bit to the how investors should be thinking about what Consensus is today.

Well, once again, thanks, Rishi, for having us. We could probably talk for an hour what is Consensus today. But I'll try to capsulize it from where you launched it, because it is true that this business unit, which is now it's an independent public company, really goes all the way back to the beginning, what was J2 Global, and J2 Global Inc., actually a company I've had varying degrees of relationship with for about 24 years. So for me, it's also kind of a full circle round trip. You're correct. It started off as a digital fax company. Ultimately, over the years, moved into the cloud. It's catered from everything from individuals up through SMBs predominantly and then more recently, the enterprises. And historically, the industry verticals that were served were regulated industries such as finance, law, compliance. And on a SOHO base, we have all industries represented, including unregulated industries. We have retail in there, we have restaurants, et cetera. And what is interesting about where the company is now is when the Affordable Care Act was passed, I believe it was in March of 2010, we actually discussed that time internally was the health care space an area of opportunity because there was this movement within the ACA for the digitization of information, medical information. We studied it, we decided that there were a few things that made it not quite right for us. Part of it was us, part of it was the act. As you probably know, it took several years for the act to actually have all of its regulations filled in. And of course, it was challenged or threatened to be challenged over time. So that was one of the reasons we stood back is that in the early days, it just wasn't clear what that law actually meant from a practical standpoint. But also, we looked at the system and the system you can look at from one perspective has been very challenging. But in that challenge is where the opportunity is. So we passed on it in the early years of the 2010 decade. But by about 2017, a lot of those issues had sunset. Rights were in place, the law seem to be more firmly ensconced. There was a push towards EHRs and EMRs, electronic health and medical record systems. There were companies like Epic and Cerner out there selling those. We said, you know, what's interesting is that the fax component is sort of the least common denominator language that they all speak. So there isn't a role for fax in the health care. It's a highly used protocol for sending medical information. How can we convince them like we've done in these other industries that digital or cloud fax is better than on-prem fax. And in order to do that, we decided we need to make some investments in the core network systems and technology of what was then known as eFax. And so we did that because you have to be HIPAA compliant in order to be able to transmit medical information around the system. That was in '17, as you saw from sort of the preparatory work and the Form 10. From '17 group spin, about $70-plus million was invested by J2 into Consensus, specifically to address the health care opportunity. A couple of small acquisitions, increased R&D efforts. But I'd say the big piece was after we started to make these investments, we saw that there was really an opportunity for us in the leadership component., And there's a little bit of old J2 history which I won't get into but the cloud businesses as you remember them, the cloud segment really didn't have in 2018 the structure that the media businesses did in terms of divisional presidents BU leadership. And that was actually good news because the digital fax business unit was the largest in J2 at that time and at the date of spin. And so when we look for what kind of skills that we want to run it, we said we want someone actually that has knowledge of the health worker space. And that's how John came to us. And we hired him in the middle of '18. John has had tenure at Orion Health and Allscripts. He came in, saw what we had done, said, I think not bad, but you guys need to do more. And let me kind of educate you on where you need to go. And it's been a real success story. A lot of that $70 million investment was under his leadership and while he was running the business unit. And if we leap forward to today at the time of spin, a full 1/3 of our business, which is about $350 million is in the health care space. More than 50% though, of our corporate business, which is meaning we're not transacting with the individuals is in the health care space. And you can kind of look at it as a layered approach. So layer #1, which we've been executing on and we continue to execute on, is teeming away the on-prem fax solutions and moving them into the cloud under our solution. That's the bulk of that 33% of the total business and more than 50% of the corporate of about 100 million. But then with John's leadership, we began to develop additional solutions because the issue is really a bigger one. Fax addresses it to some degree, but it's one of the interoperability of how do you move medical information around this very complicated system in the U.S. You're talking about patients, doctors, hospitals, labs, pharmacies, payers. All of them to varying degrees, need certain amount of medical information for the system to work. So this is broadly termed the interoperability problem challenger issue. And so we began then to say, well, how can we be a piece of that solution? Cloud fax is an element of it. But there are other protocols by who way could move information such as direct security messaging, HL-7 and Fire. So the first idea was what if we bundle these solutions under a common platform, which we call Consensus Unite. We're actually agnostic as to which protocol you use. So yes, while it's true that we have a deep history in cloud fax that is our depth of knowledge and our roots, we're really indifferent whether we use the direct secure messaging, HL7 or Fire because the way the service is sold. The way we're compensated, it's pretty much the same across the various protocols. We then said a digital signature, but one with blockchain technology to be very useful in the health care space. By the way, it has applicability in other industry verticals. So jSign, which is in the process really of being released right now, it's been released to certain of our customers, but not all yet. Then we have a Consensus Signal that was also released fairly recently, which is dealing with the emissions discharge and transfer of a patient as that individual moves around the hospital gets discharged and say, goes to assisted living. And then we have a couple of services that are under development. We call them Consensus Clarity and Consensus Harmony, you'll be hearing a lot more about those as Clarity should be released early next year and Harmony late next year or early '23, although Clarity is something that John demoed and the team at HIMSS, which was held in Las Vegas in August, even back in August of this year, we had enough of the components that we could put together for a demo. So I think the way people should look at Consensus is our focus is on the movement of secure mission and critical information, primarily in the health care space in a seamless, transparent and easy way. Now we still have a very nice book of business in finance. We have a nice book of business in legal. We have a fairly large set of individual and very small business customers. We continue to service it. They're very important to us. We will continue to take what we're developing for health care and where applicable, adapt it for these other industry verticals. But health care, first and foremost, is our focus.

Great. That's a super helpful overview. A lot that we can drill into that. I want to start by just thinking about health care, right. Obviously, there's a huge opportunity here. As you think about health care sitting at about 50% of your corporate business over now, how do you think about what that mix over the long term looks like, especially with all these new products? You've been talking about Clarity and Harmony in a minute, but how does that mix tend to look like over time?

Well, that's basically going to evolve because if you look at, let say, the top 200 customers in corporate, I think 60 -- about 2/3 are health care. If you look at what is driving the corporate business, 60-some percent of the new customers and new revenue coming in is health care. So that 51/49 that you're referencing in the split of health care, nonhealthcare and corporate, over the next 2 years is going to continue to move with that small majority that exists now is going to become larger and larger and larger. Because one, the incremental revenue predominantly is coming from the health care space; and two, the services that we're developing is first and foremost, catering into the health care space. So it's only going to continue to add to the portfolio that both our corporate salespeople have and our SMB, you can think of them almost as telesales people have in their kit to sell.

Got it. That's helpful. Then I'd love to drill down into both Clarity and Harmony. Can you talk a little bit about those products? And really, what they bring to the table that isn't already in the portfolio?

So I'm going to let John take it. He demoed it at his just by about 2.5, 3 months ago. And I'll let John take it from there.

Thank you, Scott. Clarity is a particularly interesting product. We really are applying automated intelligence and machine learning to the problem of understanding words and context. And what you actually get is natural language processing, which I'm sure many of you are familiar with. It's been the technology people have used for voice to text, for example, or the other way around, text to voice. Natural language processing allows for intelligent extraction of information from documents. So if you can think about a document in transit via maybe effects document. For example. Clarity would be able to extract information from that document and deliver it as discrete data that could be filed into a modern database. In the demonstration that we did at HIMSS, for example, we took a document that was faxed, in this example, it was being faxed from a home health care worker who is visiting a patient to the local hospitals Epic system. What, happened is that the home health care worker set of facts and we were able to deliver to the Epic system and HL7 message that was then filed into the patient's EHR record. And that's really the strength of clarity -- It allows you to transform information from 1 form to another form in transit and thereby making that information most useful at the point where it's delivered to the customer, the end user.

And then John, why don't you talk a little about Harman, which is not quite as far along, but also very interesting.

Yes, a big problem in health care is the number of interfaces that need to be maintained by health care organizations in order to communicate around their health care ecosystem. Each of these interfaces usually has a single purpose. For example, you'll have an interface to talk to a lab company or you'll have an interface to talk to your medication company to a pharmacy. You'll have an interface to talk to your insurance company. What we've discovered is that in the business that we do, we already deliver electronic information to many of these kinds of entities already. And what we can do is using a hub and spoke kind of configuration, be a single connection for a health care organization that allows for communication among all this health care ecosystem without having to have a single interface connection for each of them. So by connecting to the Consensus Harmony network, you can, in fact, connect to hundreds of thousands of endpoints and not have to build your own interface every time that you want to have a new connection over the ecosystem because we do that already. and Harmony will allow for a much more efficient, much more cost-effective way of connecting communication to health care organizations.

Got it. Got it. And as we think about solving the problem, what is it that health care organizations are using for this today? Because it seems like a major problem, and I'm sure others have tried to solve it in the past. What are you displacing when you're landing in with both current and then future products?

Health care organizations have used a variety of different kinds of protocols to communicate. And depending on the sender and the receiver ensuring that you could sink those things up was usually somewhat of a challenge. The difficulty in health care is that as many technology firms have emerged and grown up, they picked the technology that they deal with in a health care setting with HL7 technology, for example, where they deal with direct secure messaging, for example. We think we're unique in the industry in that we're really agnostic to what kind of protocol is being used. So whether you use fax protocol HL-7, Fire, use direct secure messaging, or you want to use a digital signature as a vessel for delivering documents, which you can do, we supply all of those things and the ability in the middle to transform it. So you don't have to worry anymore about whether you're using the right tool to send something to the point in the health care ecosystem or, frankly, the business ecosystem that you want to communicate with. If you communicate through consensus, not only can we accept the protocol that you're using, our transformation engine will allow you to deliver it in the way the receiver would like to have it send the fax, deliver an HL7 message, for example, based on the choices. And I think that we're unique in the industry and that we're approaching it, not as we're tied to any 1 protocol or technology but we want to be able to be the mass translator in the middle that can allow for those transactions to happen very seamlessly and very frictionlessly.

I think maybe it's less about displacement than it is how you get these protocols to be more efficient and effective in your own use. And then if you are the recipient what is the protocol you'd prefer to receive the data in, which may or may not be what the sender has in terms of their capabilities of sending. We see a lot of case situations where you might be the sophisticated hospital in an era the center with all of these protocols available, but the information is coming maybe from a small rural environment. And they might only have the ability to send it via fax. So while that may or may not be the large institutions preference for receipt, if it can receive a bit, which it can, it can then manipulate it and have it the ultimate output in whatever format is most effective and efficient for it and for its EHR that it's associated with. So I think that's really kind of the way to think of it, being this entity in the middle facilitating the flow of information and the translation in that language that is most appropriate given the circumstances.

Got you, got you. So as you think about going after this large opportunity in health care, what should we, on the outside, be looking at in order to attract the progress on all these initiatives to see the success of newer products?

Yes, I think there's a few things to look at it. So one of the things we published, done it a couple of times now, is the actual we call it a product road map. It's really a service road map. There are no hard goods, if you will, that we are developing. These are all software solutions. So we have that. Right now, it arcs through the end of 2022, early '23. We will be extending that road map into the future. So from a sort of first set of milestones is are we hitting the release date for these services, that's number one. Most of these will map to the corporate channel, almost, if not exclusively primarily. So from a data standpoint, you'll look at the metrics that we report, the total number of customers, probably most notably the ARPU, the average revenue these accounts produced per month and the retention rate or the retention/cancel rate depending on how you want to look at it. Now specifically to track how new services are generating revenue with customers, that's going to have to be incremental information that we'll provide in the context of earnings calls. Because the formal metrics for each of our 2 streams of revenues or number of accounts, new paid ads during that period, the cancel rate associated with it, and the ARPU. And those are consistent metrics we have for both the SoHo channel, which you can think of as the small individual small businesses as well as the corporate channel. But everything we're talking about here really gears itself to corporate -- So it's moving at a top line needle in terms of total revenue to growth and then the subcomponent parts in terms of how do we get there. Is it through increases in ARPU because we're selling in to the existing base, or is it expanding our reach of customers, and you're seeing actually the number of customers grow. I think it's going to be both. You're going to see a continuation of the expansion of ARPU as we get more revenue per account, but also these will lure in more accounts, so you should see account growth off of the roughly 45,000 that we have today in corporate.

Got it, got it.

And I know, Rishi, you won't be on the call to ask questions. You'll remind us to talk about how Clarity is doing or Unite or how the suite of new services are doing. So I'm sure there won't be any shines on your part.

Absolutely. You know me too well, Scott, absolutely. All right, and maybe when we think about developing these products, I think it's interesting to me given J2's history and track record of M&A. A lot of this is organically developed. How should we be thinking about now the investment opportunities to do organic product development versus future M&A, right? If I'm not mistaken, the fax business was never a big acquirer. It was the cash flow engine that allowed acquisitions throughout the rest of J2. Now that you're kind of stand-alone, how should we be thinking about M&A from here as well?

So I think actually there's 2 points to your question. How should we think about M&A? How should we think about our OpEx, I mean because the 2 go hand in hand. So you're correct, in the J2 model, all go was, and I won't speak for Ziff Davis prospectively, but generating a lot of free cash flow, bring up to the parent has a portfolio of assets where we reallocate that money, including stock back, right? Like those were the investment or capital allocation choices. And so a lot of if you look at the history of J2, including in the fax business, but in the other cloud services and media businesses, things were bought versus development. Brands were purchased, content was purchased, new services were purchased. And there's a model there to do that. You can run the math, you know what you're buying. The only question is efficiency of integration and things like that. When we looked at spinning out Consensus, one of the things that was important to me, and it was already said, already being demonstrated pre-spin, Consensus, in some respects, has greater control of its future. Because one of the things that you're tethered to M&A is, well, is it the right price? Is it the right company? Is it the right cultural fit? It's all these questions. And look, I think at J2, I'd like to believe we did a great job in lining those up on average across all the business units to do very well by shareholders. But we are a much smaller company. I don't have digital media assets to invest in and other things to redirect the free cash flow. And as you know, a lot of the things we're talking about now fall into the health care IT space. And as I tell people, we're accustomed to multiples of EBITDA. They're putting those multiples of EBITDA on revenue. And so we have a financial lens by which we look at M&A as well. And when you start putting high single-digit multiples on revenue it's very, very hard. It depends a lot on return, on economic return. I don't care what your hurdle rating is. It's difficult. So we look at it and I said, I don't want to be dependent or reliant on buying technology, employee bases, et cetera, -- So we have to build it internally. Now what it does is it means, and we've noted this in the Form 10, we've talked about this on a couple of the calls we've had. We're going to bring the margins in from the pro forma margins you see. So in J2, this was a business unit. There were about $10 million of other costs borne by the divisional parent called Cloud Services and the ultimate parent J2 Global Inc., well this business unit needs that $10 million. Those are primarily people. And then in addition to that, there's another $10 million to stand up a public company, right? We've got a separate board. We've got separate auditors, et cetera, et cetera. So there's about $20 million of costs that are being borne by Consensus as a stand-alone company versus a BU inside of the structure of J2 Global. And at the same time we're doing that, although we're going to layer it out over 2.5 years, we're going to approximately double the size of our R&D workforce. Now they may not all be employees, some may be contractors, some will be domiciled in the U.S., some will be non-U.S. domicile. But the key is really those FTE equivalents to go up dramatically because we are going to reinvest some of that margin and cash flow back into our sales. And this is why we guided people to a roughly 55% EBITDA margin. versus, say, the 57 in change that you saw in Q3 pro forma or even what our Q4 guidance would signal, which is 56.5% roughly at the midpoint. So we intend to make those advancements. They're all not going to occur at a moment in time. We have a staged approach to do it because the reality is we have to absorb not only additional engineers into Consensus, we have to absorb additional corporate people into consensus. And so there's a pace at which we can do that. But you should be expecting the trade-off to be somewhat lower EBITDA margin, but still very healthy. In lieu of M&A that doesn't mean we won't do any M&A. We've looked prior to spin. We look now post spin. But I think for us, M&A will occur every couple of years and probably would not consume anywhere near all of our free cash flow because we're geared to throw off around $100 million or more in free cash flow annually. That's after my debt service, cash taxes and core CapEx, even expansionary CapEx. So we're going to be building cash over the next couple of years. Unfortunately, the way the spin was structured from a tax-free standpoint and cannot formally repay any debt for 2 years. And the bonds are structured that way. So if we don't deploy some M&A, you'll just see the cash balances increase on our balance sheet.

Got it, got it, helpful. All right. Scott, you talked about the margins in your kind of long-term model coming down a little bit just because of the investments in organic. What about the long-term growth trajectory, right? So you talk about this long-term profile of 5% to 9%, let's call it organic growth because you're not going to be buying 5 companies every quarter now. What is it that's giving you confidence in the ability to sustain that level of growth rates? Is it the focus as an independent company now? Is it coming from newer products? How should we think about that?

Yes. It's all of the above. I mean certainly is the same. We're not focused now on maximizing the cash flow that might service other ideas within, say, a broader portfolio. It's all reinvested in ourselves. I polled said, look, everyone's all excited about being a stand-alone company, I said but I understand it's a standalone public company, all the scrutiny is on us. There's nothing that can "cover" if you miss a milestone, you miss sort of an earnings guidance. There's nowhere to look. So that clearly is an element that people are focused on, I think, accrues the benefit of the top line growth. Part of it is also the math, right? We have these 2 channels of revenue. The SoHo channel, the individuals goes back in our -- it'll grow 1% to 2%. The corporate though, is growing low double digits, like in the low 12%, 13% range. That is being driven off the back of the on-trade of the health care space, the early contribution of the existing new services. So as I look out over a couple 3 years, I expect that level of growth to perpetuate itself in corporate, and it will overtake some time late next year, the SoHo channel. So the math is working in my favor, right? If I have a larger channel growing 11%, 12%, 13% and my smaller channel is growing 1% to 2%, that's going to bias up my total growth, my average total growth for the company as a whole. And then that's going to be supplemented by the introduction of new services. And I would say even the services we have today are currently modest contributors. Part of it is because we launched some in the midst of the pandemic. And a lot of these are meant to be sold face to face, not via the Zoom or an equivalent protocol. So we started to see traction in the new services that have currently been released. jSign is brand new. But if I put all that together and all that's going to go in effect predominantly, if not exclusive, my corporate channel, it should sustain I hope even expanded that growth rate of corporate. And then the goal will be obviously to maintain that 1% to 2% in SoHo. So you run that math out a few years, there should be an upward bias to grow, but comfortably in that 5% to 9% range. Look, I have an ambition over time. When this all comes together in the works, we bust through the high end of that range from an organic growth standpoint. But that's for later.

All right, great, that's really helpful. And it looks like we're already up on time. So I think I can cut it off there. But this has been super helpful. Scott, John, Adam. Really appreciate all the time, and thank you, everyone, for joining us.

Rishi and RBC, thank you. We've had a good day of one-on-ones, and I appreciate your support. Thank you.

Yes, thank you very much.

Thanks.