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

[Technical Difficulty] conference. We're thrilled to be back in person in Boca Raton and we're also thrilled to have Consensus Cloud Solutions with us, we have Scott Turicchi, CEO and Adam Varon, SVP of Finance. So Scott and Adam, thank you so much for being with us. And I think you've got some slides you want to go through first and then we'll have a lot of time for Q&A as well.

We do. Thank you, Anna. So what we thought we would do is just present a very truncated version of the slide deck you can find at our website, so if you want to learn more, go to consensus.com. It's the forward-looking statements, Safe-Harbor language. You'll notice, we filed an 8-K I think a few minutes ago just reaffirming the guidance that we reaffirmed in our Q3 earnings call, the annual ranges which Adam will get to in a few minutes. So I thought I do is spend a little bit of time talking about the history of the company. Some of you that have followed the old J2 will know the history, but those of you there are new to us, we were spun out of J2 Global about a year ago, on October 7th of 2021, but our history goes back actually into the late 90s when we were founded as [ jfax.com ]. So the first sort of decade of our life, we had the development of we call the SoHo digital cloud fax business, very architected differently in that area than it is today based on things like [ sip ] technologies exist today that didn't exist back then. The idea at the time was that individual users and business would buy their own solution, many of them will get expensed, reimbursed from their companies and so it's small office home office, but over the years we learned actually they were firm out of enterprises that use the solution in various departments. The core brands that we use today to market that service are eFax, MetroFax, MyFax and fax.com. Now as I mentioned, we started to look at the data in the underlying customers in the early-to-mid hours and we found that there were domained very large companies who were using our service, but we had no corporate relationship with them. So that really started the evolution of building we now call our corporate channel. First, going to the small to mid size business. The SoHo channel is all sold online. You go to a website, you learn about the service, there are some product demos, it's almost exclusively charged by credit or debit card and there is virtually no human interaction in terms of a sales rep at Consensus. The model starts to shift as we move into the corporate channel. On the SMB side, that is generally up to a few 100 numbers per account and as few as about 10 numbers per account. And here you will talk to somebody, it's our in-house telesales team which we have based in Las Vegas, Los Angeles and Ottawa, Canada. They'll get a little bit more into how you're going to use the service, some of your work flows, eFax Corporate is the core brand there. We have sFax and MyFax corporate as well, which are alternative brands that we sell for our corporate users. And then if we jump forward into about the 2016, '17 timeframe, we began to architect the solution to go after medium to large enterprises and this really dovetails with what Consensus is all about today and why we were spun out of J2 Global about a year ago. The real emphasis of the enterprise space today is in the healthcare sector. In the late 2010's era finance, legal some government agencies in manufacturing tended to be more early adopters of the solution, but healthcare in large part because of a variety of regulatory issues that they have regarding HIPAA, privacy etc., they were much later adopters. So you recall that the Affordable Care Act was passed in March of 2010. It was a big push towards digitization of medical records and medical information. However, like all things took about a decade for it to really gain some traction. So while we have booked at entering the healthcare sector back in 2011, 2012, we decided that based on the newness of the law and you may recall there were challenges at the time about 4 or 5 years including Supreme Court challenges, we figured we would continue to focus on those other industries like finance, legal and compliance. However, by 2017, the law was settled, EHRs were rolling out, but one thing that was very clear is that fax was the core predominant mode of transfer of information, certainly in the United States of healthcare information. So we upgraded our solutions, we added features for the enterprise, built out a sales force and not only do we sell the eFax Corporate Solution, but we have a series we call advanced interoperable solutions such as [ Unite ], jSign and Clarity, very briefly Unite bundles several core protocols that are used in the healthcare sector for the transmission of information. They include fax, direct secure messaging, which you can think of as an encrypted form of email, HL7 and [ Fire ]. JSign is a digital signature that was really designed for the benefit of the healthcare space, although, we do offer it to our other clients. And Clarity, which was released earlier this year takes the fax images, which are pictures and unpacks that data so they can be put into a structured format. So our goal is to become the leading provider of secure data for enterprises, particularly in the healthcare space, as it relates to interoperability. We do as I mentioned though serve other regulated industry that tends to be our preference has been for many years, although, certainly within the SoHo and [ S&P ] sector, we have a wide swath of customers, including those in the retail space and accounting and other areas like that. The key to the success of the business is to be high-speed reliable and trusted, to be compliant not only within the healthcare space, the HIPAA laws, but there is a third party who will review you that as an [ entity ] called HITRUST, so certain of our services are HITRUST certified, others were in the process of being HITRUST certified. And then since we are a global company, the respecting of regional data sovereignty although about 85% of our revenue is in the US. On an LTM basis through September, we had $369 million of revenues, 54.3% EBITDA margin, but I would note the fourth quarter of last year was the transition quarter from being spun out, so when we start talking about comparisons to 2021, the first 3 quarters were all on a pro-forma basis. The growth rate was about 6% for the whole company, but it was led by our corporate channel at just under 15%. On this complicated slide which I won't go into great detail really shows overtime the release of our advanced interoperable solutions and the growth in the TAM. So we start with the digital fax space, that's a 2 some more current estimates say us up to a $3 billion market opportunity. Then as we start layering in the Direct Secure Messaging, the Fire, the digital signatures, you get up to $8 billion. And then with Clarity and the advancement of Harmony, which will be released in pieces in 2023 and beyond, which is really a set of APIs to make the transmission of information even more easily accessible amongst various healthcare providers, that will get to up to about $11 billion TAM. So the goal is a integrated consolidated platform that can be used. It can be attached to a given EHR which we do today or it can be bought on a standalone basis by a either very large institution like a medical system or a smaller say doctors group practice. I'll now have Adam come up and he'll walk you through some of the key elements of our financials.

Thank you, Scott and it's a pleasure to be here, all of you. I'm going to talk about the Consensus customer profile overview, as Scott mentioned, it's a continuum of customers. We go from the SoHo channel or small office home office through the SMB and into the enterprise, the latter 2 being our corporate channel. With regard to SoHo, high volume, low touch, online, it's e-commerce SaaS model. That model is about 90% mix, subscription rates 10%, variable revenue and usage. So small packages with small usage volumes. As you move up the continuum of customers, you get into the SMB channel. That SMB channel is an inside sales SaaS model, think of it as telesales, people on the phone calling up, taking leads, do an ABM based marketing programs etc. Those customers are on a sales cycle that's fairly quick one to 3 days typically, some of the larger SMB to [ SMBe ] we call it or maybe a month, 2 months max, which require some negotiation about 20% under contract, typically 3 years. And those are month-to-month and annual and the difference as you go up market into the SMB channel is the packages have more usage volume. So the mix is more like 65/35 from an MRR subscription revenue versus a variable revenue. Then you go all the way up market and you get into the big enterprise level customers. Those customers are a long sales cycle, 12 to 18 months, complicated sales, migrations of -- did very, very -- can be very complex and very robust depending upon the implementation whether it's going from on-prem to the cloud or cloud-to-cloud, it depends. Those contracts are 3 year contracts with one year auto-renew. Typically those contracts are not that guarantee with respect to fixed revenue, so it's a 30% fixed, 70% variable, so the usage actually drives those customers. One thing to mention on the entire corporate base is the LTM revenue retention rate is greater than 100%, kind of a same store sales look over the last 12 months. Moving on to the next slide, we have our Q3 2022 results. We had $95.9 million in revenue in the third quarter, which was an all-time record for us. That was a $6.7 million increase over Q3 of 2021, which was 7.5% on a constant dollar basis over $8.1 million or 9.2% year-over-year due to FX headwinds. Our adjusted EBITDA was up about $400,000, roughly 1% and it was a 53.5% EBITDA margin, which was in-line with our -- fully in-line with our expectations. When you get to adjusted EPS, we were up $0.08, about 5.6% and that was largely due to increased revenues and to a lesser degree the impacting extent of foreign exchange resulting from the strong dollar. All-in-all, our Q3 results were in-line with expectations in a very challenging economic environment which we all know, which we're finding out while we're here. With regard to our full-year guidance, we are reaffirming as Scott mentioned, on the revenue and EBITDA side, we're guiding to the lower-end of the range, that is primarily due to the timing of large customer wins and new product adoption within our customer base. With that though, our pipeline continues to be very robust and in the mid to long -- and the short to midterm timeframe looks very, very solid. On our non-GAAP EPS, we're guiding to the higher end of the range or the top end of the range due to the strong U.S. dollar, which is providing a bit of a benefit with respect to our Euro denominated liabilities and the revaluation on the balance sheet. With that, I will pass it back to Scott, where he will talk about our capital structure. Thank you.

Great. Thanks, Adam. I would just note what Adam was saying, FX primarily the euro and the Japanese yen, they hurt us in revenue and EBITDA, but they benefit us below the line because of a variety of intercompany relationships that are Euro denominated. So actually when you look at the movement in the midpoint of the guidance the lower end, about half of that is FX related and the other half is what Adam mentioned, which has to do with the timing of either implementation and/or wins of certain large customer accounts. So as of the end of Q3, the September 30 balance sheet, $104 million of cash, large chunk of that is truly excess cash. We do need a little bit to run the business in terms of working capital, primarily in the U.S. and we need few million dollars scattered around the world, primarily in Euros, GBP, Canadian dollars and Japanese yen. We have 2 tranches of notes that were issued at the time of spin, 5-year notes and 7-year notes, they're now 4 and 6 respectively, $305 million at 6%, $500 million at 6.5% non-call 2 non-call 5, a lot of that was dictated by the IRS private letter ruling for the tax-free nature of the spin. So we are not in the position of being able to retire debt even in the open market until we hit the second anniversary of the spin, which is October of next year. I would also note we have a $25 million undrawn unused line of credit expandable to $50 million. It's just there really as an additional safety net, no intention at this point to draw upon it given the cash balances that we have. So that brings us to a total debt of $805 million, $701 million on a net basis, an LTM EBITDA of $200 million, so it's 4x on a gross leverage basis, 3.5x on a net. And I would note that when we think of leverage, as I say, we were spun at about a 4x gross debt to EBITDA, that was just the nature of the spin. It is our goal, we have the flexibility to retire debt and/or refinance it, to get down to 3x gross debt to EBITDA. So at some point, we'll likely use some of the free cash flow we generate to actually retire some debt. We are a fairly good free cash flow producer, but I would remind you, our free cash flow predominantly comes in Qs one and 3 because we make our interest payments in 2 and our. And 2 and 4 have the burden of about $26 million of interest payments in each of those 2 periods. We're targeting around $100 million of free cash flow, it will be somewhat less than that this year, in part because we had additional payments to the former parent, Ziff Davis in terms of settling up fees and expenses and things like that post the spin. And our capital allocation is, we look for, first and foremost, reinvesting in the business. We've had a substantial number of hires this year. It's one of the reasons you saw the margin for Q3 of this year, lower than Q3 on a pro forma basis of last year. We've added about 100 employees since the spin, plus we did a small acquisition that brought us an additional 30. So that had and that was all planned, it was all known. So we'll continue to make investments there. They lead the things like the VA contract that with our partner Cognizant who is the prime was awarded a little over a year ago and now has received the authority to operate. So that's really the core focus. We will look at M&A, we did a small deal in February this year. I would say it's not really the focus of this company, unlike, say, J2, the former parent, but from time to time I suspect we will execute on things that are consistent with our product roadmap and do not cause a distraction in the core operational business as it relates to integration. Deleveraging, I talked about and then opportunistic share repurchases. The former parent owned 99 at the spin. They sold a bunch of stock in the middle of the year, they're down now to under 6%, that caused some downward pressure. We took advantage of that about 200,000 shares at $40 during the summer. And then our short to intermediate financial targets are 5% to 9% revenue growth, 50% to 55% EBITDA margins and about $100 million a year in our levered free cash flow. Obviously, as it relates to 2023, we're in the budgetary season now. We'll release our Q4 results, which will be in February. We will then have revenue, adjusted EBITDA and non-GAAP EPS for 2023. These are just to give you some broader targets over the next couple to 3 years.

Okay. Great. Thanks so much. So let me kick it off. So let's start with SoHo. So who are your active users? Like who are these people at home using eFax?

Well, they're a combination of people. So there are people that worked out of their home even before the pandemic. So they would be salespeople, they would be accountants who are often not in their office, but it ranges. We have plumbers, we have doctors, we have retail. It's basically very small micro businesses, so you shouldn't think of them all as true individuals working out of their home, although that is a large share of them. But it doesn't include small businesses because the SoHo channel will sell up to 10 seats of service under one account. Once you trigger beyond that and then we want to have a conversation with you, you're moving into the next zone. The SMB channel has a wider swath of services they can offer versus the SoHo channel.

Okay.

It's all purely automated. SoHo, just to be clear, sells almost exclusively cloud fax, right? As of a year ago, they had the opportunity to sell the jSign digital signature, but that's it, they don't sell Unite, they don't sell clarity, those more sophisticated solutions that are predominantly focused on healthcare are not available to them.

Okay. And then it's 90% subscription, so what percent of your customer base are active users versus somebody who just wants that capability like having the fax machine there just in case you need to send a fax every once in a while?

Well, it depends how you define active. We think of them all as active. We agree that there are some that have higher consistent usage versus those that have it to your point for an occasional use where they may use it from time-to-time and remember it's bidirectional. So there are recipients and there are senders, so you can be a user just by sitting back and publishing the telephone number and having it be received.

Got it.

I don't -- I don't know, we've never published the number in terms of delineating between those different categories.

It's anecdotally, okay. And then you've also cited on the FX side, I think you've cited FX as a headwind to revenue...

And EBITDA.

So what's the geographic footprint of the -- and EBITDA of the customer base and so...

Yes, more so -- 80 -- most of it is sold by the way. Most of the FX relates to sold very little corporate, almost all of corporate is the U.S. So in the SoHo channel, you've got Europe predominantly for us the Euro more than the GBP, the yen because we actually have an operation in Japan is the second most important currency. Then it would go down from there Canadian dollar, Aussie dollar, the Nordic currencies and then the GBP.

Yes and our overall base is really about 85% US, 15% rest of the World.

Specifically in SoHo, it's about 90 -- 90% of the customer base is U.S., 10% is rest of the world.

Okay. And then I think you recently instituted price increases. How material were the increases and what has that done for churn?

Yes, so beginning -- at the beginning of Q3, so it means July, there were around 1 million customers in SoHo. So this does not affect the corporate channel, this is the SoHo channel. About a 1/3 of the base during the quarter was effective. There's another 20-some percent of the base that are under annual contracts, so they are only affected as they come up for renewal, it's fairly ratable. So think of 5 points a quarter, meaning Qs 3, 4, one and 2, but it will arc into Q2. There was another 1/3 of the base that was [ grandfathered ] in large part because either they were new customers, so we didn't think it was right to go and institute a price change or they were already on a special enhanced package, they already had premium pricing essentially. And that leaves you a small sliver that doesn't fall into one of those categories. So that third 300 some thousand we affected, you'll notice if you look sequentially boosted the ARPA or the average revenue per account from Q2 to Q3 by $0.50, $0.60, the average price raise was between USD1 and USD2 depending upon your existing price point. What was interesting is that while the cancel rate was slightly up above the norm, it was actually down from Q2. Now Q2 had some unusual effects, so it was at the 3.8% range in Q2, it dipped down to 3.6%, but the 3.6% would be elevated over a 3.4% to 3.5%, what I'll call normal run rate. So it actually performed better than the testing we had done in the May and June time frame because the way we do these price changes and by the way it also affects new customers. So if you come to the website, the new customer also are paying a higher price as well as that portion of the base that's been affected. So we test those both for new customer acquisition, as well as to the base. If we're satisfied with the results, there's net economic positive benefit, then we begin to roll it out and that's what happened. You will see some continuation of the price change in Q4 partially because of the annuals, but also we've taken a look at that piece that was not in one of those categories and some of those will get price affected in Q4 and likely in Q1. So by the time we hit the middle of next year, the whole base of SoHo will be on the new price points.

Okay. And is the outlook for this segment slow secular decline? And so accounts have continued to drop off...

Yes.

Revenue was down 3% year-over-year, you had FX headwinds. But think about it, I mean someone who still has FX capability today, the propensity to churn is probably going down over time, right? So I guess, how do you think about the [indiscernible].

When you look at new customer acquisition and we present our churn numbers raw for those that remember the J2 days, there was a different calculation, our numbers are raw. So customers in, customers out cancel rate. What you find is that after 6 months is a dramatic fall-off in the cancellation. So while we count the customer from the moment of acquisition, there's a very high churn in the first 6 months in the SoHo channel. Once you get them over 6 months and certainly over a year, they become lifers. So in answer to your first question, we look at this as being we call a flattish business in revenue, so there could be some account drop off with the price changes that mitigates it who knows where FX will be next year in terms of that component. When we say flattish, it might be down minus 3% to plus 3% in any given period from a revenue perspective and we manage around it. What we don't do is we don't make a lot of investments in new products and services for the benefit of the SoHo channel, all of our R&D development is for the benefit of the corporate channel, where we can cleave off a piece and offer to SoHo like jSign we do that. But it's not as though there's a specific product road map and investment strategy for SoHo. So the goal is really maintenance of that base from a revenue and by whatever implication EBITDA or free cash flow perspective because it's not actually a segment, it's a stream of revenue, there's no separate accounting for it, but to maintain that as best we can and really put all of our emphasis on the corporate channel, which as you can see is the one growing 15%, it's where the opportunities are, it's where the large customers are like the VA, etc.

Okay. So switching to enterprise, which is now -- well, I guess, corporate is...

Corporate which includes SMB enterprise.

Is the bigger part of the company now.

Correct.

So I think you said you service 4 of the top 10 largest healthcare entities.

That's correct.

So when you're going in to pitch that fifth guy, what is your sales pitch? What are you doing better? Why would they go...

We generally start with the fax solution and the reason we start is our core business, going back 20-some years. But also as I mentioned, there is a large amount of healthcare information that is sent via fax, it was just a study done, 75% roughly of personal medical information is sent by a fax versus these other alternative protocols I mentioned. Most of that faxing is we call on-prem fax, meaning it's a combination of multifunction devices, individual machines and fax servers. So first and foremost, there's a -- in almost all instances a value proposition that is very positive in decommissioning that equipment and moving over digital fax solution, we lead with the fax, we're HITRUST certified, so we meet the standards of compliance for the healthcare industry. And then it goes a step deeper, which is we have to understand what is your workflow, because everyone thinks you're just selling services and the fax comes in and hit some body's inbox, no. In the enterprise, it's not what's going on. The documents are coming in, they're being routed to specific servers or routed to specific inboxes. We have to understand all that. The impediment in knocking these all down one, 2, 3, 4, 5 is if you've made an investment in that on-prem equipment recently, you'll live with it for a while because the investment is upfront. Ours is pay as you go, as Adam mentioned, 70% is literally pay as you go, it's based on your usage consumption, only 30% is fixed. But if you spend millions of dollars on servers, software and paid-up licenses, you're going to live with that 4 to 5 years. So we have to -- the key for us is to be in contact with not only these large providers, but the next several tears down and to understand when is a data center refreshment coming up, when are they about to end of life their current on-prem solution so that we can then offer them the right solution in terms of the cloud.

Okay. I think you did a good job addressing the capital structure, which shows your still a CFO head...

No, no, I knew that.

You are not a CFO, but you can very fluidly step into those slides because Scott was the long-term CFO of -- well with J2.

Yes, the capital structure is important to us. I say it's not one we would have designed for ourselves if this were an IPO in the traditional sense, but it was the price of being release from J2.

Right.

J2 had to get certain benefits, it was done in a very interesting way, tax free, all this stuff and so $800 million was the magic number. It happened to be 4x debt-to-EBITDA, comfortable for us, particularly at 6%, 6.5% rate, not 8% or 9%, but probably would be today.

Lift pricing at the time, but looking pretty good now.

But we're pretty good enough, but we want to lower that debt. I mean our commitment at the time when we sold the debt and to the rating agencies was the goal is 3x gross debt to EBITDA, we just can't get there as expedition as we might like because of the restrictions put on by the spin itself.

So do you have a credit rating target and yes.

I think look, given our size, I think even with the deleveraging, maybe we pick up a third B, but I think getting the 4 Bs is not in the near to intermediate term because the rating agencies are critical of size. We have a lot of EBITDA, but we don't have a lot of revenue. We have high EBITDA margins, that's always a knock, it was a knock at J2. So I want to maintain the 2 Bs, I want to get to 3 Bs, but...

I hate to say it, they might just hear the word fax and I mean which is [indiscernible] misunderstood part of -- that is all that comes to me.

Yes, that's true.

Yes.

But the size, $350 million, $369 million of revs, $400 million of rev, I mean they're looking -- they want $1 billion in revs. It will take us a while to get there, not that but that's not an objective and a goal or an aspiration, but I think realistically maybe when we get through the complete cycle, meaning the maturity of these debts and we're in year 6 and we've actually paid some down and we contemplate what a more global refinancing looks like, maybe we have a shot at it.

I mean the other thing that may give them pause is a concern on how acquisitive you might be and what that might do...

Yes, one of them as noted that as I say, I continue to downplay the acquisitions, we're not J2. We're not trying to do x deals a quarter, but we have so many organic opportunities, but to me M&A has the potential of being a real distraction and we cannot have that. We're doing a lot on the product side organically in terms of building services. We obviously have a lot of services that are fairly new to sell and I know what happens. You mentioned M&A, who wants to run the new thing, it's exciting, it's different, it's different people, it's maybe new technology, there's an integration. So we have been very, very cautious. We look, I mean, you've got to look, it's important to look. Summit was a very nice tuck-in. It complemented the needs we had for people, particularly in certain areas of HL7 expertise, professional services. So that was a very light integration. Also as you may infer, even in this environment, some of the valuation expectations remain very lofty when you say healthcare IT. And the things that we're interested in purchasing and you see developing really fall into that category. We're not so much interested in buying the next cloud fax company because we can strip out lot of costs and have marginal margins of 70%, which we could do. But that then requires the integration work and that would then be a distraction for our technical team. So I think you're right, there are those who say, well, wait a minute, the leopard can't change its spot, but it is really something I'm not that interested in doing.

Okay.

Not at least for the next year or so.

Okay. And with that, I think we're out of time. So Scott, Adam, thank you so much. It's a super interesting story and thank you for sharing.

Thank you very much.

Thanks for having us.