Verisk Analytics, Inc. (VRSK) Earnings Call Transcript & Summary

Okay. Let's keep things going here. I'm Gary Bisbee, business information services analyst at BofA Securities. And glad to have Verisk here to talk us through their business. From the company, we have Chief Financial Officer, Lee Shavel, and I guess I should really say Chief Financial Officer and Group President with oversight of Energy and Specialized and also Financial Services. The new title is a mouthful. But congratulations, I guess, on that additional -- and Lee, thanks for joining us. I appreciate you being here.

Well, great. Gary, it's -- first of all, thank you very much. Very excited about the new opportunity, but more importantly, delighted to be here at the conference, whether in this context or in person. It's just great to be meeting with so many investors, and the attendance has been fantastic. There always is a warm spot for me at BofA Securities since I spent about 2 decades of my career at BofA and Merrill. So I'm delighted to have a conversation with you today.

Yes. Good. One of the first things when I joined the firm was -- and people saw what I was covering, was people -- your friends and former colleagues reached out to me, more than a dozen of them, if I remember correctly.

But -- well -- so let's start with that new expansion of your title. And the question I've got a lot from investors is do you taking on direct oversight of Financial Services and Energy and specialized, does that increase the scrutiny at all of their place in the portfolio? Or is that not part of the thought process around this?

Right. So it's an understandable question, Gary. And I would start off by saying that the additional responsibilities that I've picked up weren't catalyzed by a specific determination to kind of review the overall portfolio or these businesses, but it really was fundamentally -- when I had the great opportunity to join Verisk about 3 years ago, I laid out a plan for Scott in terms of what I thought I could accomplish in helping the business, implementing our return on invested capital framework to help complement our financial disciplines, rethinking the way we approached M&A. We're really thrilled with the progress and the results that we've shown on that front. We've stood up a more sophisticated treasury operation. We've substantially enhanced our procurement function. And we've really upgraded our Investor Relations approach, thanks to the contributions from Stacey. So having accomplished a lot of that and I think having finance in a good place, we talked about how I can be helpful to the business in a broader sense. And Scott suggested that an opportunity to oversee the Energy and the Financial Services businesses would be a good opportunity to gain operating experience. And to your question, Gary, I think it represents 2 things: one, a projection of my focus around returns and capital management and value creation more directly into those businesses. It's always been a -- certainly a focus for us and we've always thought about how are we creating value for shareholders, but I bring a particular lens. And I think it also is functionally an opportunity for a fresh set of eyes to think about the businesses, how they relate to one another, how they relate to the whole. And what I'm trying to do is complement my top-down understanding of the businesses with a bottoms-up people, products, clients understanding so that we can evaluate how this fits, what our incremental returns are on capital, how we allocate to them and ultimately, how we create optimal value for shareholders out of the entire business. But importantly, nothing is off the table in terms of evaluating how we best do that.

Okay. All right. That makes a lot of sense to me. If I turn to the fourth quarter results for a second, I think it highlighted a frustration investors have had, which is that both Energy and specialized and Financial Services continue to underperform, from an organic revenue growth perspective, the strong Insurance core of the company. And I think this has resulted, if we look back, at failing to deliver that 7%-plus revenue -- organic revenue growth target basically in 5 straight years on a total company basis. Now clearly, there were some real weather challenges in 2018 that I think the business would have certainly delivered that without it. And we just went through the biggest pandemic in 100-plus years. So I understand there's other factors, but nonetheless, those businesses continue to under-grow Insurance. And so maybe a question about that on each of them. For Financial Services, revenue has basically organically been flat for 4 years. There were 3 somewhat chunky acquisitions in 2017 that were expected to bolster the portfolio and position it to return to growth. It really hasn't done so. And over that period, margins have contracted a lot. So despite being fairly small in the portfolio, the business has clearly been a significant drag on revenue and profit growth. At what point does that underperformance become an issue in whether that's deciding there's a better use of your capital or a better owner even for the business? And so are we getting towards that point of sort of frustration that you would consider more aggressively thinking about its place in the portfolio?

Yes. Gary, thanks for the question. And I think those are all fair observations and legitimate questions that we have to evaluate. I think from the outside, if you look at those results, I think those are understandable when you look at the overall performance. And of course, sitting from the inside, we have the advantage of trying to look at the components of that performance and what the drivers are. And so I want to -- perhaps utilizing the fourth quarter results, I realize that you appropriately are looking over a longer period of time, but I think it's important that we understand a couple of components because each of them are salient in what we're seeing in the business as a whole. The first, as you referenced, is that we were dealing with the impact of the pandemic on all of our businesses, but the Financial Services business is the one that had the highest percentage of COVID-sensitive revenues relative to their base. And it's a function that, certainly, the spending element, the bankruptcy businesses are all significantly influenced by what we're experiencing right now. So our first objective is, all right, so to what extent has that been an influence on the overall growth rate? And so we see that our bankruptcy-oriented businesses, one of the acquisitions that you referenced, is experiencing a lower level of revenues due to depressed bankruptcy volume given the levels of government support that is being provided. And so that certainly is environmental. On the spend informed analytics, which had contributed substantial amount of growth in the past and was a great opportunity for us to leverage our proprietary data set, we also saw reduced levels of advertising that influenced our ability to grow that business. And that's a function of the fact that people aren't commuting, there's less demand for advertising, and so that's influencing it. And then in the fourth quarter, one other element is we typically see a seasonally high level of project analytics on the part of our bank clients that are planning for the areas that they want to focus on ahead. And what we heard from them consistently was, "We were anticipating a higher level of credit losses," not surprising, "and we're tightening our belts and we want to see how the year plays out." Now that's typically concentrated in the fourth quarter, but there are elements in the rest. So I think those are all understandable impacts for the business. And our expectation is that as the pandemic proceeds through '21, that with varying degrees of recovery curves, we will see an improvement in -- I say improvement carefully with regard to bankruptcy but I should say increase in bankruptcies that will drive the business, that we will see more advertising and pick up on spend informed analytics. And we would expect, towards the end of the year, we see a pickup again on the analytics front. So that's one component that I think we can identify and set aside for a moment as not being indicative of the progress of the business. The second element that we talked about are some contract transitions that we -- that occurred in 2020. One of them was the exit of a reseller relationship in our bankruptcy business who decided that it wasn't critical to their overall business. And so that had an impact in a part of the business. But more importantly, we had a significant spend informed analytics client that we had an opportunity to recast our contractual relationship with and shifted the revenue relationship from more front-end revenue to a more sustained longer-term revenue realization from that relationship. And it was absolutely the right thing to do, and it was a reflection of the steps that our management team in that business have taken to shift from a more front-end-oriented kind of consulting business to a more sustainable growth-oriented business, and that will benefit us from the way we think about the business and the way the business performs. And while that is having a near-term impact in the fourth quarter and will continue to have an impact over the next 3 quarters, it is fundamentally a positive, positive chain -- change to the business. Now when you take those out, that's obviously a lot of noise that is obscuring beneath that fundamental growth in our subscription businesses achieved over that time as a function of the investments that we're making in some of our constituent businesses. And so we believe that there is demonstrable progress when you eliminate the noise, and yes, it's a lot of noise. But the contractual issues are finite, and they will be -- probably we'll be through those by the end of the third quarter. And the COVID, I think we all have a reasonable expectation that those will recover. The short-term expectation -- and we usually don't give as much color around this, but I think given the focus on this, we want everyone to understand. The year-over-year decline in revenues that we saw in the fourth quarter, we expect to persist at proportionally that level for the first 3 quarters because of those contractual transitions and the ongoing impact of COVID-19, particularly in the first quarter, where we still have a pre-pandemic and post-pandemic impact.

Right. Okay. And yet -- I appreciate all that. It doesn't really get at the core of the question though about longer-term failure to live up to Insurance. So is that -- how do you think about that? I guess what I heard you say is you believe when we peel back some of this noise and some of these shorter-term issues, that progress has been made towards growing the business in the future. Is that...

Yes. Thank you, Gary. And I didn't mean to ignore that element of the question. I knew I was giving you a long answer to the short-term issue. And I wanted to -- I didn't want to overwhelm me, but -- yes. So I think there are a couple of points that we want to make. So will we continue to see the progress towards a sustainable growth rate that is consistent with our target for that business? And I think we believe, given the quality of the data set, the investments that we're making in new opportunities, that, that is an achievable target for us in the near-term as we get through this noise. Now I also want to say that we're not -- that isn't going to prevent us from looking at the business in terms of: Does it have sufficient industry scale to monetize the investments that we're making relative to other competitors in the place? How are we creating value? And probably what's most important for me is as we're investing incremental capital in that business, are we generating or are we anticipating generating attractive returns in excess of our cost of capital to demonstrate value creation in the business? But we will be looking at all of those and evaluating where is the optimal portfolio allocation for our shareholders.

Okay. And if I could ask a quicker question on Energy. Energy has been a far better performer. And while revenue has been sluggish in frequent periods, you've actually had quite strong profit growth the last few years from this business. But it clearly feels a little more cyclical and I think harder to make the case that it could be a 7%-plus grower. It's done that once in the 6 years you've owned it. So I continue to get the question from investors. How does it fit in with the Insurance business? And is Verisk the best owner for those assets? How do you answer those questions?

Yes. Gary, another absolutely relevant, relevant question. And I think in this context, it's more important to understand the journey that we've been on with our Energy vertical as a whole. And what I mean by that is, when we got into this business with the Wood Mackenzie acquisition, it was a great, well-respected name in research -- energy research and consulting. And it represented a starting point for us with good data sets and great relationships and industry scale in energy that we viewed as an opportunity to move increasingly over time to more of a data and analytics business, centralizing those data sets, beginning to apply analytical techniques and approaches that opened up new channels of growth for us and improve the operating leverage of the business to create a similar value engine as we've had within the Insurance business. And I think the broader vision is that the energy sector as a whole, particularly as it's changing and transitioning to alternative fuel sources, decarbonization, that the changes and the quantitative nature of tracking those changes through sensors, through observations, through aerial imagery, through industry data is creating a very rich environment for us to play that industry role in serving the industry and leveraging those investments that we can make on behalf of the industry to create value for them, and that's the journey that we've been on. We have demonstrated that we've been able to create, despite this environment, growth in our subscription revenues, which -- in a difficult environment, in a down cycle environment, which has been differentiated relative to our competition in this space, and it reflects fundamentally a very important proof point for us. And that's the Lens platform. We've talked before about the Lens platform as being a cloud-based environment that we are populating with our data sets, and it's enabling us to allow our clients to interact with that data directly. It's allowing us to create new analytics by tying together these data sets, particularly as we look at the full value chain in energy supply and energy demand that this transition is playing itself across. And the evidence is that we're now in a position where we are securing meaningful price increases on multiyear contracts with our clients on those traditional subscriptions. And that's even before we continue to capitalize on the ability to create new analytics and products. We also have seen in our PowerAdvocate business the ability to create entirely new data sets in PowerAdvocate space of a collection of capital cost and operating cost benchmarks for participants in the energy industry that will be critical to helping them navigate efficiently through this new environment. And we've seen within our energy transition -- chemicals business, which will be very relevant in this transition, and the metals and mining area double-digit growth rates in our research and consulting businesses, reflecting the opportunity that we have ahead of us. So I think to your point, we have seen some of the early-stage evidence of our progression on that path, but we're really excited about positioning ourselves against that longer-term opportunity of serving the energy industry as a primary data and analytics provider. That's certainly what we view as what will drive us to those achievable growth rates.

Okay. That's good color. The -- you mentioned earlier the number of the things you've accomplished since you -- a lot actually in a fairly short period. One that I thought was really critical when you joined the company and were tasked with a number of things was this concept of bringing more rigor to the returns focus of the business overall, M&A, several things. And not to ignore everything else that I think you've done, but a couple -- 2-plus years in, can you just discuss maybe at a high level what you've accomplished on that front? I think it was something investors were very worried about prior to you joining, and I certainly think there's a number of places where we've seen improvement that you've delivered. But how would you assess what you've done from a returns perspective? And are there other key things to do? Or is it really just operating in the framework that you've now pushed throughout the organization?

Yes. Thank you, Gary. And it is certainly the accomplishment that I'm most -- we have tremendous opportunities to deploy that in a variety of ways. And going into this, I think the focus had been understandably on revenue growth and margin. But if you're optimizing for revenue growth and margin, you can potentially do that without necessarily optimizing your capital returns. Or said in a different way and sometimes a more damaging way, if you're optimizing for margin, you may hold back on investment because those are typically going to require -- are going to consume margin in the near term. And so what we've done is we have a framework now where we can see what the invested capital is within each of our business units. We understand the capital generation in terms of NOPLAT for those businesses, and we can now inform a discussion at the business unit level and at the corporate level around how we want to allocate our capital and what is the return potential for each of those investments. And while you can't quantify every investment that you're making, you can't identify every investment that you're making, for the big, chunky ones, we now can have a discussion and understand why this is a good return opportunity for us. And in a way, I think that's one of the biggest value contribution opportunities for us within Verisk, to deploy that capital where we can use our industry leverage to monetize a new analytic or solution. Now what does that mean? We've just gone through the budget process. And Scott and Mark and I have looked at our CapEx budget, and we've made specific allocation decisions about where we're going to allocate not only CapEx but where we're going to allocate a variety of OpEx-oriented investments. And we're doing that from a lens of where do we see the best returns. Now we're considering growth, we're considering margin, we're considering risk associated with all of that, but it just provides another dimension for us to make better decisions on that front. And then finally, Gary, probably the most important benefit from my perspective is that we've fundamentally changed our approach to M&A. And what that entails is that historically, we had understandably kind of a portfolio approach, which is let's look for businesses that have very similar Verisk qualities to them and we should make them part of the family because they've got the same characteristics that we have. And when valuations are low -- and that can be a great way to build businesses, and we've had a lot of successes in a number of our businesses that we acquired that way, Xactware, AIR being one of those. They benefited from being businesses where I don't think investors appreciated the value of those businesses as Verisk did early on. But in an environment where valuations are as high as they are, if that's the approach, you've almost failed before you've left the starting gate. And what we've shifted to is a very business unit-oriented approach, where the business unit has to sponsor that acquisition because they're in the best position to be accountable for delivering on those results and are in the best position to actually achieve the benefits of improving our distribution of that product, improving the technology, taking costs out. And the practical effect has been that we've done a better job of achieving our original expectations on the deals. We've generated returns higher in our 3E acquisition of the SAP content business. In the first year, we delivered a 10% return on invested capital, which the business unit team was as thrilled as I was to achieve that. And I think you have seen a change in the scale of the acquisitions that we are making, generally under $200 million and probably more focused on the insurance side than they would have been historically, reflecting the fact that that's where we can probably add the most value. So I think we've really improved that dimension. We've really enhanced the integration plan that we've developed. Our head of M&A has worked to establish someone who's solely responsible for tracking the business and making certain that we're delivering everything we can to that acquisition to make it successful. And I think that's fundamentally changed it. So I'll stop there, but those are the elements that I think we've had the greatest impact on.

Yes. No, that's very helpful color. Maybe one on margins. And this is probably the single most asked question I get about Verisk from investors, so I know you've heard it before. But your target over the long term is to deliver EBITDA growth in excess of revenue growth, which implies some level of margin expansion. And you accomplish that on an organic basis, the metric you provide in the last 2 years. So that's obviously positive. But I continue to get the question, and I wonder this myself. Is mix really a long-term headwind to delivering on margin? And in the perspective through which I ask, prior to you recasting the segments, which I thought was a big improvement, by the way, but the former risk or RA segment exhibited slower growth and had much higher margins, and the faster growth DA segment had much lower margins. And so it just felt like the mix shift was going against this ability to deliver margin expansion. Certainly, a lot of the things you've acquired since making that change, you've acknowledged initially that the margins are lower and they're driving growth. So is -- looking at it through that lens, is that fair? Or are there some reasons that maybe that -- you changed it because that was not a good way to look at it and you don't see mix as a meaningful headwind to delivering some margin expansion over the medium term?

Right. So Gary, thanks for articulating that question, and it is a very common question and one that I wrestle with a lot. And I want to kind of take it because I think one of the fundamental challenges in talking about margin with investors is that it's understandable that investors tend to look at margin as a monolithic metric, meaning that they're looking at Verisk's margin and they're kind of thinking of it as kind of one uniform business across the entity. And as you've suggested with your comments, the impact on margin overall is going to be influenced by a variety of things, one of which everyone understands, which is the impact of acquisitions. If we are acquiring earlier-stage, higher-growth businesses, they typically are going to be lower margins overall. And so that's going to influence the business. The other very important element that we've tried to isolate is the impact of investment on our overall margins. And one kind of fundamental thesis I have is that our opportunity to create value for investors is really driven by our ability to deploy capital into the business and into M&A opportunities where we can generate good returns. And so when I think about margin, and I do this every quarter, I look at it at a corporate level and a consolidated level and at a business unit level. What's most important to me is that excluding the impact of the mix shift in M&A, portfolio impact of an M&A -- of an acquisition at lower margins and the impact of our level of investment is going to skew the change in that margin. And so what we do is we try to eliminate the big, chunky elements of investment. So at a corporate level, investments in things like Lens, in the telematics business, in our cyber insurance business, in a variety of those big, big areas that we're investing, we take those out because we track them as individual projects. And we're not ignoring them, I'll come back to them in a minute, but we set them aside so that I can look at the operating margin, the EBITDA margin number and see if the operating leverage is expressing itself through margin expansion excluding those impacts. And what we have seen is that we are generally able with our normalized growth rates to achieve 100 to 150 basis points of EBITDA margin expansion from our normal growth rate. And then what we are striving to do, balancing the investment objective is to consume some but not all of that margin expansion through our investment activities and our M&A activities that are supportive of our growth. What we're trying not to do is to drive margin increase at the expense of substantial investment opportunities that we have to drive returns and aggregate EBITDA growth. That's why we're focusing on organic EBITDA growth because that's operating cash flow growth. If we can get operating cash flow growth and great returns, we're creating value for shareholders. We have investors, as reflected in your question, that are very focused on margin. And we understand that, and we manage it in that context so that we can achieve margin expansion. But it's going to vary based upon noise on that level of investment and actual results. We have other very large significant investors who say, "Why do I care about margin? What I want are good returns and growth, and you shouldn't be constrained by the margin outcome." So we try to keep a healthy balance between those 2. And I will submit our opportunities to invest at good returns remain one of the strongest aspects of Verisk from a shareholder value standpoint.

Yes. Okay. That's helpful color. If I could ask sort of a 2-parter on the technology and innovation. So you've discussed for a number of years now this process of modernizing and upgrading tech infrastructure, moving to the cloud and some other aspects of it, and you've talked about not the big bang we've seen some others do but doing it over time. I respect the fact you're not adding back a lot of cost, by the way, as you do that, think of that as a normal course investment. I think you've alluded to, and here's the questions, some cost savings or efficiency on the other side of getting this done. And so in the short term, while you're still working through this, is it fair to think that you are beginning to face some duplicate costs as you're winding up cloud costs but still not shutting down legacy infrastructure? And is that a meaningful sort of cost item or drag to margin as we continue to work through this? And the second part is when others have done this, we've seen a real revenue benefit from their ability to innovate and spin up new offerings more quickly. And I think maybe you've alluded to that, but that hasn't been discussed as much as I know you're asked a lot about costs. So I guess could you weigh in on both of those?

Absolutely. And to your first question, the answer is undoubtedly yes. And in fact, I know it, because having gone through the budget process, we get a lot of whinging around kind of the bearing of the cloud transition costs as we're going through this process because it is a substantial increase. And in many cases, we do are experiencing duplicative costs within some of the businesses as we are ramping up the cloud environment before we have been able to fully exit the legacy on-premises kind of data environment. And so that is absolutely a real burden that we bear. I also want to emphasize that this is a process that we're -- we are moving hundreds of data sets in a wide variety of products. And so it's a bit of a campaign where we've got a lot of different units marching in a direction here, and we are completing some of the earlier projects. And one of the benefits of that is that we can see on those early projects that we are realizing savings. We're reducing both from an OpEx standpoint and from a CapEx standpoint. But the bulk of the projects are still in that duplicative phase, and we're kind of working our way to a point where we still have more of a cost than a benefit. But over time, we will begin to see that benefit flow through to the business. Again, that will factor into our overall margin. But it's undoubted -- I have no doubt that the investment that we're making from a capital standpoint and an OpEx perspective in that environment is producing a positive return in terms of our ability to save OpEx and CapEx, and it's just more efficient. To the second part of your question, absolutely that the centralization of those data sets in a cloud environment is facilitating a number of benefits. One is just our ability to work with data sets across individual vertical units. And we're seeing that probably the clearest example of that is within our Lens environment that we have developed. So we are now able to look across operating data in different asset classes and begin to draw correlations, begin to apply machine learning techniques to the correlation of those data sets, which inform what's happening across the power grid or the energy market as a whole. And I think we see similar opportunities to connect some of the weather data that we and the modeling that we capture in AIR to activity within the energy industry, which we've all kind of seen the impact of how weather can influence the energy industry with the recent situation in Texas and broadly across the insurance side, those data sets. The other element is that it's enabling, as with Lens, the ability for our clients to interact directly with that data, which adds value and creates new revenue opportunities. So yes, we believe that is fundamentally added to our top line growth as we advance on that mission.

And at the risk of going a minute over, I've got to ask one question about Insurance, your best business and largest business, which I got through this without. And so I'll keep it simply at this. You've discussed over time the ability to penetrate clients. At Investor Day, you showed this chart of the number of services they're using is going up. As you sit here and look forward at the next, let's say, 24 months or 2, 3 years, can you just give us what are the 2 or 3 most exciting, largest opportunities, either new things you're working on or things that are early in that penetration curve? What should we be asking you about that could be incremental growth drivers in the next couple of years in Insurance?

Right. So I'll tell you, Gary, the thing that is amazing about our Insurance business isn't -- aren't the specific opportunities but the sheer breadth of opportunities. I often describe our business as being driven by 2 primary engines. The Verisk plane, there's 2 big engines on it. One is the growing level of relevant data sets in this industry, encompassing sense data, physical data, aerial imagery data, satellite data, social media data that now has relevance to a lot of life insurance applications; and the growing demand for the insurance industry for our analytics that we can develop with greater efficiency for the industry as a whole than them individually. And while we are seeing great success in those in specific areas like the LightSpeed product with -- in our life insurance area, in our cyber insurance area, in a variety of claims applications, it is the sheer breadth of what we can pursue across the industry that I think is the most exciting aspect of our Insurance business.

Great. Well, that's a lot of good color. Lee, thank you very much for joining us today. I think we'll have to leave it there for time.

Great. Wonderful. Great spending time with you, Gary.

Thank you.