Ziff Davis, Inc. (ZD) Earnings Call Transcript & Summary

Good morning, and welcome to the Bank of America Leveraged Finance Conference and to our session with J2 Global. I'm Ana Goshko, the credit analyst covering technology and telecom and will be moderating our discussion today. We're thrilled to have with us Scott Turicchi. He's J2 Global President and CFO. [Operator Instructions] And with that, let's get started. Scott, thank you so much for being with us. And maybe to kick it off...

Ana, thanks very much. Go right ahead.

So to kick it off, for those on the call that might be newer to J2, could you just provide us a brief overview of the company's 2 business segments, Cloud and Digital Media in order to kick us off?

Absolutely. So as Ana just mentioned, we have 2 business segments. Now underneath those business segments are a variety of businesses that aggregate up. But from a reporting standpoint, we report what we call the Cloud segment. So these are cloud and SaaS services, primarily cater to small to medium-sized businesses and small to medium-sized enterprises, although we do have some large corporate customers and we also do have some consumers that take our services. And these are predominantly what I call business tools. In fact, we've seen some pickup in the early days of COVID as people moved to work from home because the portfolio of services include things like digital fax numbers; digital voice numbers; Virtual PBX; second line service; a portfolio of security protocols that range from email protection, endpoint security, VPN, backup, and then what we call SMB enablement, which would be our voice and our martech services. And so those businesses aggregate, we call the Cloud segment. If we look back over the last trailing 12 months, they're going to be roughly equal in size with the Digital Media business that I'll talk about in a minute in terms of revenue, but the Cloud has a higher EBITDA target margin. So without any push down of corporate expenses from the parent, that Cloud business has a target margin of around 50% EBITDA and is a subscription-driven business. So everything we do there is subscription-oriented, although there are different ways that people pay us from month-to-month via credit card, to annual subscriptions to even 3 year subscriptions that are paid in arrears. I would also note that about 85%, 86% of that revenue comes from the fixed subscription fee. The balance comes from variable revenue, which is primarily usage. So depending upon how you buy, you get a certain amount of usage for a given service. When you consume more of that, you pay incrementally. That creates our variable revenue. The other side is the Digital Media segment. And from an operational standpoint, we have actually 2 divisions that make up the Digital Media segment. One is called Ziff Davis. It primarily focuses on content in the tech, games and e-commerce or virtual shopping environment. And then the second is Everyday Health Group, which as the name implies, is focused on things related to healthcare. So once again, before the acquisition of RetailMeNot, which closed in late October of this year, so in Q4, roughly equal in size from a revenue standpoint with our Cloud business but it has a target margin of 35% of EBITDA. Its business model is more advertising-driven. We do have subscriptions in the Digital Media business. They account for about 25%, 26% of its revenue. Once again, this is before the acquisition of RetailMeNot, and 75% would be advertising. That advertising is split into 2 categories. Display video, so as you surf through websites and you see ads presented on a web page or pop-ups or video preroll, that's what we call display video. And then the other piece is performance-based marketing, which is we get paid when a good is sold. We move traffic to somebody else's website, we generate a lead. Those are all things that are known as performance-based marketing. Of the 75 points between those 2, there's slightly more display video than performance-based marketing. However, with the acquisition of RetailMeNot, that's going to flip in Q4 and going forward as that business, which is about $180 million of trailing 12-months revenue, is substantially all performance-based markets. So hopefully, that gives you some understanding at a high level of the 2 segments and the underlying business models in which they operate. I would note that even though 75% of the media business is advertising revenue, they are about 1,000 or so advertisers, and they're highly recurring. What we don't know from year-to-year is their spend with us, and their spend is often influenced by product cycles, or in the case of healthcare, drug cycles. So drugs that are being approved by the FDA that are going to market, those things influence the volume of spend online generally for these companies. And then, of course, what share can we get of their total online spend. But it's not as though it is episodic and we have to find new advertisers each year. It's generally the same pool. It's just the volume with which they advertise is largely driven by their own activities.

Okay. Great. So that was very helpful base to start with for our discussion. So kind of switching to strategy and kind of how you manage and -- these segments and businesses within them, which of your businesses are you managing for growth? And if so, what's kind of the organic growth goals that you have? And then also, are there some of your businesses that are better managed for free cash flow? And if so, which ones are those?

Yes. So just to start with that. So we believe in total growth. The total growth means the organic growth, which is applicable to certain of our business units, and then the M&A piece that is done either within the year or that it annualized from the prior year. So as a company, and it never works this way perfectly, we'd like to have double-digit total growth year in and year out. Now realistically, because when the M&A comes in, like a RetailMeNot, and it's a larger deal that can bias your metrics or the proportionality between acquired growth versus organic. But to be clear, within the company, there is not an organic growth metric or hurdle or compensation scheme. It's all about really total growth and really the EBITDA that you can generate from your portfolio. Having said that, there are assets within J2 that, to certain degrees, we run for revenue growth. Now we don't run any of our assets like you would see independent public companies pursuing an organic growth story and sometimes doing that at the expense of sacrificing EBITDA. We absolutely do not do that. So even when we talk about growth assets, they are required to contribute to a certain target level of EBITDA. Generally, that's going to be at least in the 30% range. So while we have aggregate EBITDA margins in the low 40s, like 40%, 41%, you can't want to grow business and be detrimental to that total margin by very much. Now where we see growth in the Cloud, and this will surprise people, the corporate fax piece. That is a high single to low double-digit organic growth. That's about $140 million business that these days, its new customer acquisition is primarily focused on healthcare. So its incumbent base would be areas like legal, finance, accountancy, consultancy, remote workers. But going forward, and really over the last 2 years, the focus has been on the healthcare space. And we've seen some, I think, aid from the COVID world, not necessarily in the early days of March, April, but subsequent to there being a sort of a new normal as these hospitals and doctors' offices are having to do things in a more digital way than they were previously accustomed to. So that $140 million business in Cloud is a growth business. The VPN business that we bought about 18, 19 months ago, IPVanish is a growth business. The drags in the Cloud business have been the backup business, which, as we noted before, is in a state of sort of managed decline but maintaining the margins as best we can. And it has suffered from COVID. And it's been harder to gain new customers because a portion of their base was done in a more traditional selling model. And then the web fax piece, so the original J2 entity going way back in our history. This is individuals who take digital fax services from us. They generally work from home or in very small group environment. That generally has a low to mid-single-digit annual decline of revenue. Somewhat ironically, it's actually done better post-COVID. So we're at the lower end of that range of decline this year versus what might be sort of mid-single digits in, say, last number of preceding years. So those would be within -- so we manage those for cash flow, to your point, the EBITDA and cash flow. It's like, okay, hunker down, manage those things as best you can. Don't chase revenue growth just for the sake of revenue growth, particularly if that would be uneconomic. I would say, generally, on the media side, the whole healthcare portfolio is growth-oriented. You might have heard in the last earnings call, it was -- it grew 25%, Q3 of 2020 versus Q3 of 2019. Approximately half of that came from an M&A deal done a year ago, a BabyCenter that's in for a full quarter in Q3 of 2020 but not the full quarter of '23, '19. But the remainder of that would be organic. So it's a double-digit organic grower but still throwing off 35% EBITDA margins. Within Ziff Davis, I would say we have 2 categories. The broadband business, which some people know as Ookla and Ekahau, that's a growth business. And the gaming business, which would be IGN and Humble Bundle. Those generally are also low double-digit organic growers. But once again, with the same caveat, they've got to produce the margin. And then those that are more cash flow-oriented would be Ziff Davis Media Group and Ziff Davis B2B, which are primarily content lead generators for the tech set.

Okay. That's super helpful. A couple of follow-ups to that. So clearly, it's -- you're very much kind of a bottoms-up kind of management approach. Are all of your businesses really have kind of their target EBITDA margin? And if not, where do you think you've got room for improvement? And then the second question is, are there any target metrics that you use to manage J2 at the consolidated level?

Let me answer the second question first, which is generally no, because we are the sum of the parts. And you can look at the parts really being the 3 divisions or the 2 segments. So a lot of our aggregate metrics, financial metrics are literally the proportionality between the 2 segments. Having said that, it is sort of a philosophical goal that we maintain some balance between the 2 segments. Obviously, the timing of M&A and the size of M&A can tip the scales, whether you're looking at revenue or EBITDA more in favor of one segment or the other. But the goal would be sort of to be "in balance," meaning that over time, you might not be 50-50 between the 2 segments with revenue, but you'd be somewhere between 60-40, 40-60, and you vary within that range. So we like the fact that we have 40% or better aggregate EBITDA margins. We are sensitive to that but wouldn't say we necessarily manage to that margin metric in the aggregate because, as I say, if you end up with a series of media deals that hit their target margin in the mid-30s, that's going to put a weight on your total aggregated margin, even though those deals might very well be fantastic deals coming in at 5x or even better EBITDA. So would be motivated to do them even if momentarily, it might give us a lower than 40% EBITDA margin. Go back to your first question? You're asking about are we generally at optimal margins now? The answer to that other than things we recently acquired is more often yes than no. So the big opportunities for margin improvement are generally things that we've acquired within the last year. Certainly, work is on the table right now for Ziff Davis and for the Media segment is RetailMeNot. While it has good margins in the low 30s, we believe we can drive that over the next 12 to 15 months to 40% EBITDA margin. Those are annualized margins because like all of our media businesses, there's variations in the margins by quarter. Q4 is a very strong margin quarter. Q1 is a weak margin quarter. We're talking about averages for a trailing 12 months. So I would say, clearly, RetailMeNot, having just acquired it, we're at a very sensitive time of the year. We won't touch that asset until January in terms of any integration or optimization. So that's a 2021 event. We have some smaller deals that we've done throughout this year or late last year. Those are also ripe for optimization. But I would say the core business units today and the core divisions are with maybe 1 or 2 exceptions, close or at their target margins.

Okay. Great. Helpful. So a couple of follow-ups on some specific business questions that I think we get frequently. And then -- so following up on RetailMeNot. So that was J2's -- I believe it was your second largest acquisition. Obviously, very recent. And then back on the envelope, it seems like it was about a 7x multiple on a trailing basis. And so obviously, kind of a value investment, I think. So what are the issues in the business that you were able to acquire it for that relatively -- a modest multiple? And then how do you plan to maximize the value and make money on it?

So I think as to the former -- and this is something that has benefited us in the past. There's 2 elements in terms of how do we get a good price out of an asset. One is patience. Now you could define patience in this deal going back almost 10 years when Vivek, not affiliated with J2 at that time, looked to buy RetailMeNot. This is obviously pre its IPO, it was a much smaller company. And the price just wasn't right, so it was taken over by a private equity firm. It was taken public, and then ultimately, it was purchased by an entity called Vericast that's owned by MacAndrews & Forbes. Even in the most current round, meaning this year, when it was clear they would be put up for sale, they had expectations that, in our judgment, while maybe possible, we're not -- it's not what we were going to pay. And in fact, they had a -- I don't know what degree of contract, but they had some indication from a third party they would pay closer to the price that they were expecting, and that deal broke. I don't have all the information as to why it broke, how much of it was dealing with some of the litigation that was outstanding at the time that has subsequently been resolved. But they came back to us -- and those of you on this call, particularly as bondholders, I'm sure are familiar with both the Vericast financial structure and some of the things that have been publicly disclosed regarding MacAndrews & Forbes. And the divestiture of a series of assets. Well, because they had spent time trying to get a higher price, a much higher price. And then that fell part, they valued speed and certainty of closure. And so by the time that we re-engage, I want to say, within 45 days, that deal was closed. Now how could we do that? Well, we can do that because, one, we had historical knowledge of the business; two, we're in the business with Offers.com and our Black Friday portfolio of websites. And so we had a very quick insight into things that they weren't doing that in our judgment, they should be doing to create value. And then what's interesting about the COVID world is unlike the traditional world where you have a bunch of meetings and you go out and get on planes and meet face to face, because you're not doing that, the speed and the volume of data made available to us was incredible. And since, really, we were looking at gaps in feature functionality, gaps in take rate or payment rate, these things became very clear very quickly. So we said, look, we're not budging from our price that we signaled a few months ago when you first priced this asset for sale. We'll get it done in 45 days. And so that was valuable to them. We were able to close the deal within that very short time frame or at least announced the deal. There were some regulatory things like HSR that with another 2 to 3 weeks on half of that, and it's why we closed in late October. Now for us, where do we see the opportunity to improve the asset? Well, one phase that will occur next year is the integration of RetailMeNot Offers.com in the Black Friday sales. So we have a business that is about at 1/3 of the size of RetailMeNot today with our portfolio of assets. We've had great success with those. If you go back to our March Analyst day of this year, it was actually a case study that Steve Horowitz, the President of Ziff Davis, talked about. I want to say we're in, to those assets, 3x EBITDA. So one of the things that happened with Offers.com, which is the largest of the group that we owned prior to RetailMeNot, is how you move it to a higher percentage of payout for the goods that you assist in selling? RetailMeNot, probably in large part because of the history of Vericast and the couponing business there, very much had that couponing and talent. And if you go to the website today -- and I think we've made very little, if any, changes to the website since we acquired it because of the time of the year we're in. You will see, if you compare it to Offers.com, the differences. And you'll start to understand the path to upgrading the website to bring more content into the website or the app that actually helps you make a decision to buy some. When you can drive traffic to an e-commerce retailer, they'll pay you up to 10% of the cart when you check out. If all you're doing is dropping coupons while they're already in the virtual store, you'll get 3% to 5%. So right now, from the volume of goods sold, RetailMeNot get to about 4%. We get closer to 10% in our portfolio. Now you're not going to flip a switch and go from 4% to 10%. You're still going to do a lot of coupon. But the idea is you introduce content, you drive traffic to third parties for which you get that higher commission. And over time, if those are the only 2 things you do, get an uptick in that corporate average take rate. That's one element. The other element is some of your -- some of the people on the call maybe familiar with Honey, may have used it, may have people in their family that use it, which is a toolbar extension that was actually created by RetailMeNot. Their version is called Deal Finder. They then chose not to broadly distribute the Deal Finder extension. It's available on the website. If you scroll down, you'll see a button to click. If you got a Honey's website, it's very prompt. The advantage of having the tool extension is it's running in the background. And anything you buy, if there is a coupon available or a discount, gets applied and you get credit for. Now the commission rate is lower. It's generally in the 1-ish percent range, but the volume that you participate in is much larger. So Vericast didn't really have the ability, not having other digital properties to effectively promote and deploy the extension. We do. So you're going to see Deal Finder across a variety of our other properties, particularly in the Ziff Davis portfolio. You'll see it at PCMag.com, you'll see it at Mashable, you see it at IGN. Those would be obviously core properties within the Ziff portfolio. You'll see it at pregnancy and parenting in Everyday Health Group. So that would be BabyCenter and What to Expect. So we have all guide balls that come into our owned and operated digital media properties. We can now promote the extension and get people to download it at close to virtually no cost. So that's kind of the 3 pronged approach: integration; creating cost synergies; updating both the content and the way the website works to have a portion of that traffic; get a higher commission rate; and then the promotion of the Deal Finder extension, which runs in the background and is looking for deals anytime you're shopping.

Okay. Well, that's actually super interesting. Just another kind of very specific question that I'm sure you get a lot is really on the fax business. And it was helpful for you to make a distinction on -- with -- on the web fax being the kind of the older part of the business. But I think a lot of investors, particularly generals that may be taking a look J2 on the credit side, like, you hear fax and you just hear like existential kind of concerns about it. So could you explain why the eFax business has legs and can withstand kind of the threat of being replaced by some other kind of digital means or kind of technological obsolescence?

So there's a couple of reasons for that. If I told you it was document management and document movement, if we'd ever use the word fax -- and I think at this point, we wish as a company, we'd never use that 3-letter word. People go oh yes, I get it, you got to get documents around digital secure format. I get it. That's what fax is. Now I'm not here to tell you it's the only protocol by which you can move a document fast and secure. But it happens to be one that has been around a long time, so it has broad acceptance. In some instances, it's been written into the law like HIPAA laws or Gramm-Leach-Bliley laws. And so you're pretty much, if you're in certain businesses, have to have the ability to send and receive faxes. Now what proportion of your total volume of send and receive it is, would be known to your company alone in terms of what alternative means, if any, are permitted, some of which may be limited by regulation. So in many instances, we sit side by side with other protocols. You can think of an order input center that takes orders via text, via email, via media, by fax. Just 4 inputs. Okay, they need a system by which to receive the fax information and basically strip out the data from that fax document. So in some instances, we absolutely are sitting there with other protocols, which was fine. And maybe 20 years ago, it would have been the only protocol, and then these other protocols came in and chipped away at the relative proportionality of traffic. Now healthcare is an interesting one because it is, first of all, an industry that moves very slowly in its technological evolution. It happens to also be that fax is called out in things like the HIPAA laws. Also turns out many medical records, even to this day, even 11 years after the Affordable Care Act are still in written format. So the movement of those documents tends to occur very high percentage via fax. Now there are 2 other protocols that are permitted to move sensitive information -- on the unique product called CallFire and the other is an adaptation of secure email. So earlier this year, we obviously primarily focused on displacing the incumbent fax infrastructure in hospitals, large doctors, systems, labs, pharmacies. That's when we do these large-scale deployments, who we are targeting, PBMs and things like that. However, we launched a service. Unfortunately, it was launched right as COVID was coming down. So it did not get probably the the marketing oomph that we would have liked. It was supposed to have been launched at the HIMSS Conference, which is a big healthcare conference in Orlando in March, which was canceled this year. Who knows if it will be on for next year, probably doubtful. But the Consensus product actually combines the 3 approved HIPAA compliant protocols by which you can send and receive secure information. So when we sell the Consensus solution, we become actually agnostic as to which protocol is being used by the sender. Now there's a value-added feature either in just buying the standalone fax protocol from us or with an API or the Consensus, which is it allows for interoperability and movement of documents amongst various EHR and EMR systems. So that's a big emphasis of ours, which is your documents are not trapped in a Cerner EHR. They can move from a Cerner to an Epic because fax is the common language that all of these EHRs and EMRs speak. So for us, it's not just purely, hey, we can do your facing better, we can make it digital, we can probably do it more cost effectively than what you have incumbent. So we can bring you this additional value-added feature of interoperability with other systems, which is otherwise more challenging. And then if you want to go all the way to Consensus, we can bring in those other products. So it's one of the reasons why our corporate business has been growing the last couple of years, high single digits, below double digits. That's that $140 million of the $320 million of tax revenue. And in the next couple of years, few years out, it will probably be larger than the web business.

Okay. Again, super interesting. Okay. So Scott, as you and I predicted, we're kind of running out of time because there's always so much to cover. But I think it's important since this is a debt conference to focus on the company's leverage, what your target is there. And really, as we expect the company to continue to be acquisitive, how we should think about your capacity from a debt standpoint to fund additional acquisitions, especially with regard to the kinds of things you're looking at right now?

Yes. So even after RetailMeNot, we have about $200 million of cash on the balance sheet. As part of the 4 5/8 bond offering we did now about 45 days ago, we terminated the bank line down at the cloud level, which is where the old 6% notes sat. We'll be moving that line up to the parent. We just haven't gotten it done yet. It's not been a super high priority, but we'll have that $100 million available. People will note in the bond indenture, it's contemplated, that bank line could go up to $350 million to a specific carve-out for that in the incurrence of debt. We have no intention to take it at that level now. I don't know it needs to go to cash, but it will be set up to do that. And then we also have very strong free cash flow. I think about $387 million on a trailing 12-month basis through September 30. We're going into our best cash flow generative months, December, January, February and about through mid-March. The earnings from the media business that we booked in Q4, the vast majority of that revenue was collected in Q1. So we're in a very good position from an overall liquidity and cash standpoint. I would say the size of deal at RetailMeNot is not something you see us do every year. It's something -- there's no magic to it, but it seems like every 3 to 4 years, we find a deal of that size at the right price point. So while I would expect in 2021 for us to spend $300 million, $400 million in M&A, it's probably going to be fractured over a larger number of deals than in 2020. And so because of that, the combination of the cash, the line and prospective free cash flow should be sufficient to meet those needs. Now you may know or you may ask the question, when we first went out with the 4 5/8 issue, we were looking to do up to $1.2 billion. We cut that back to $750 million. A lot of the reasons we cut that back is that was kind of the amount needed to refinance the 6% notes, pay fees and expenses, pay the call premium and move the debt out of the Cloud business and up to the parent. We would have like to have gotten the other $450million, but the day that we priced it was the morning after the President and his wife announced they had COVID, and there was some volatility in the market. We saw things backing up and we said, look, we don't need that $450 million today. Why pay on the $1.2 billion a higher rate of interest for cash that is going to sit on the balance sheet, as you know, keeping it liquid and not getting much of a return? So that's going to be punitive to your P&L until you can deploy it. So we cut the deal back to $750 million. Actually, as you know, it helps the credit ratios. Our goal is sort of long-term to be not in excess of 3x total debt to EBITDA. Today, we're 2.9. That's on the trailing 12 months ended September 30, not giving effect to RetailMeNot and its EBITDA contribution. But we also, as we signaled in that offering to the rating agencies, we will take it north of 3x temporarily. We generally like to be proactive and have the cash on our balance sheet so that when a RetailMeNot comes along and when timing is sensitive, we literally could just say, "look, it's on our balance sheet. As soon as we signed the purchase agreement, and regulatory conditions are met, we can wire the money." We don't have to go raise it, we don't have to go expand our line of credit. So historically, it's been the case. We like to sit with some amount of excess cash on the balance sheet. So we've got about $200 million today. Kind of at the low end of our historic cash on the balance sheet in the last probably 8, 9 years, but not sort of out of the range.

Okay. And actually, unfortunately, with that, we're really effectively out of time. This has been great. As we said, we could have gone at least an hour because there's obviously so much to talk about with J2. But Scott, we thank you very much for being with us. And I wish you and the company all the best in 2021.

Thank you, Ana. I appreciate it -- appreciate being here today. Any of those that are listening, if you have other questions -- Ana had a great list of question. I don't know if you're going to publish the questions, but they are a great list of questions. If you got more you can reach out to me either directly or through Ana. She'd give you my contact information, I'd be happy to follow-up.

Okay. Great. Okay, thank you. Take care.