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

Okay, everyone, thank you all for tuning in to the 21st Annual Summer New Ideas Conference at CJS. We are very pleased to welcome today Scott Turicchi from J2 Global. He is the CFO of J2, and will soon become the CEO of Consensus, the announced spinoff of the cloud fax business, which should be happening a little bit later this year. I am the covering analyst for JCOM, with a $200 price target on an up-market outperform rating. We're going to launch directly into a fireside chat format. [Operator Instructions] So Scott, welcome. I'm going to start it off with an easy one for you. Just talk about the high-level motivation for the spinouts. What does this enable for both Consensus and JCOM, J2 Global to do that either of you wasn't able to do alone?

Great. Well, thanks, Jon. Thanks for having both J2 and prospectively, Consensus to be part of this conference. I think I want to take a step back on this question because while Consensus was the asset chosen, I think it's insightful to understand how J2 thinks. And I think when you look at J2 going forward, those that are J2 shareholders are interested, need to understand that this is important. So we look at the overall portfolio of J2 company, that roll-off in the 3 divisions that we've talked about extensively and we report on every quarter. One of the things I think that's become very apparent over the last probably 2 to 3 years, as you know, Vivek has been the CEO since early '18, is a constant undervaluing of some of the parts of J2. And I think that the pandemic was a very instructive time because Vivek and I got to do a lot of non-deal roadshows and one-on-one with investors that we would not have normally had the opportunity to do, at least together, if we were pre-pandemic when these conferences were physical locations and Vivek would participate in some of them that were more East Coast based. And I think a couple of things came to the fore. That 1, and we've heard this from investors over the years, J2 is perceived as being complex because we have a lot of different things going on, even though we would argue they actually do have a common theme. They do only have a couple of business models. But nevertheless, people have to get comfortable with a variety of activities in J2. Certainly, the M&A program, which has been a key driver. And one of the motivations when we looked at how do we enhance the overall value at J2 is how do you make it more simple. And we went through a lot of iteration. How you tell the story differently or better. But ultimately, it came down to, well, one of the ways you do it is you unlock pieces from J2 and give them their own platform. And of course, there's a variety of ways you can do that. You can do an outright sale. I'd say most of the assets in J2 don't really lend themselves to an outright sale because we tend to have low base even those assets. And as a result, it will be a very low [indiscernible] So it really got us thinking about, well, what are the alternative ways to unlock value whereas sale is not likely a preferred outcome? Now at the same time this was going on, this thinking. And when we think about it, we think of a whole variety of assets within the J2 portfolio. Turns out that Consensus, which is the successor of the digital fax business, is the single largest business unit in J2. $340-ish million of revs. It has got strong margins. But it also has an evolving story. And I think we'll probably get to this in some of your follow-up questions. But one of the things that has occurred in the last nearly 3.5 to 4 years is a push into the health care area, the largest sector of a global economy, heavily users of the movement of information via the fax protocol, but not exclusively. And so we started to both adapt the business to be able to legitimately play, first and foremost, at the fax level, to take over on-prem faxing solution, but also to evolve products that encompass other protocols for either document or data movement that are HIPAA compliant. So we started to see a few things going on. One is there's never enough time to tell the J2 story in 1 of these meetings, much less the Consensus story. So part of the motivation for the spin is what would each company have its own kind as a public company, its own opportunity to build its research and investor base that is going to have it uniquely focused on, in the case of Consensus, the interoperability and the solutions that are developed or already actually in the marketplace to address it. And of course, for J2, there'll be a greater orientation towards digital media going forward, but not exclusively. There will still be meaningful subscription businesses in the cloud. So that's kind of how we thought through it. Now you get to the next layer, which is when you start to separate any 2 companies, you start to think about, well, might they be run somewhat differently and might you have different incentive structures versus if they're part of the whole. And I think that, at least in the Consensus case, the answer to that is yes. As you are very familiar, every business unit in J2, every division, is geared to a certain level of EBITDA margin, which by proxy of implication need a certain level of free cash flow. And those of you that are familiar with the J2 model, these 13 business units in 3 divisions grow up about $480 million of free cash flow every year to the parent. That's after CapEx, even a little bit more or meaningfully more, if they can see CapEx. And those of us that sit at a parent look at how to reallocate that capital mostly back down to those divisions and those BUs. And most of that goes to M&A; some goes to CapEx. But then we also balance how much goes out to shareholders and stock buybacks. And then how much is reserved for larger transactions that generally set up either new business units under a current division or a new division, such as we bought Everyday Health in late '16. So that's the model under which J2 operates, and it's very important that within that model, every business unit is producing a substantial amount of EBITDA and free cash flow. So if you take Consensus without the burden of corporate overhead, it's a low 60 EBITDA margin business but obviously not much of a top line grower because those trade-offs are being made between margin and organic growth. Now when Consensus becomes a stand-alone public company, there's going to be some changes made, some moderation of that, where we are going to reinvest into the R&D efforts for the development of our own products. And I have to give J2 credit: some of that has already been done over the last 3 to 4 years, $75 million, probably $80 million of investment in real time. But we want to accelerate that. Same thing on the sales and marketing side. There's more opportunity to spend money both digitally, I think, over time to expand the breadth of the sales force. And so yes, the margins might not be as robust under J2, the trade-off will be a stronger organic growth model with still very robust margins. And so then that bleeds into the next commentary, which is well, to achieve those results, you're going to incentivize people different. J2 is very much driven in terms of our short-term incentive programs on EBITDA. And if you beat the EBITDA number, then you can have a premium to your bonus; if you miss it, a penalty. We're going to be rethinking that. We're probably going to have revenue drivers that are going to be key triggers for our bonus programs as opposed to just purely an EBITDA-driven model. So it gives the company, once they're spun out, the opportunity to rethink forms of compensation, ways that should be triggering certain behaviors that you want to achieve that might not be consistent with year 1 of a portfolio that's got to have some commonality in terms of how all of the businesses are run. So long answer, but I think it's important because this transaction, well, for myself and my team that will be going with Consensus, we're obviously thrilled. But I think it's also important for J2 because by going through this process, J2 now adds another tool to its kit for value enhancement. And I'm not projecting or I'm not in any way implying that once Consensus run out, that necessarily implies that another piece of J2 will or could be spun out. But we certainly have interesting assets in J2. Some of them are getting to a similar size of Consensus. So when you start to think about layering on the corporate overhead of being a stand-alone public company, I think you look out 2 to 3 years, it's another piece in the toolkit for J2 for value enhancing.

Got it. No, that's some good insight. Changing gears a little bit. It's a little bit ironic, Scott. You were there when J2 was only a fax business, and you're kind of coming full circle again. The difference is it's a different business now. And I think some people have a bit of a misperception around what Consensus actually does; they think of the old Webfax business. But the truth is that's going to become the smaller piece of the business soon, especially because of this corporate and health care piece. Can you tell us what it actually -- what that business actually does for corporate and healthcare customers and how that differs from the web piece in terms of service model and capabilities?

Yes. So -- and by the way, one of the things, too, that being a stand-alone company gives you opportunity is you get to present our own metrics. So as Jon's pointing out now, what you'll be seeing in our IR presentation, the regulatory filings, are 2 screens of revenue. I don't know if we're going to call it Webfax. It's probably going to be called SoHo Fax. But as Jon's implying, if you go back into the early days of J2, the whole company were basically individual, not always working out of their home, sometimes they're in a large company, but individual purchasers of solutions for digital fax. And that is a stream of revenue that's still very robust. It's about $180 million. We'll get the price talk and unpack at a little bit more in this conversation. It's not really expected to be much of a grower. We look for sort of a low single-digit organic growth on that piece of the business, which is an improvement over the way it's been run over the last few years. But then sort of maybe 10-ish years ago, the product evolved to really cater to corporates. Now those corporates range from small businesses or through very large enterprises, both domestically and in international jurisdictions. And these have, depending on the industry you're in, special tools or the way documents flow through that particular industry or that particular company, security and privacy protocols, et cetera. So we cut our teeth in verticals such as finance, legal, compliance, accountancy in the corporate space and built a very nice book of business, probably approaching $100 million. The last vertical, though, that was non-participatory in the movement to cloud or digital fax was the health care space. And there are a lot of reasons for that. A lot of it having to do around HIPAA compliance and the punitive nature if you're in violation of the HIPAA compliance laws. We had actually looked at J2 by getting into the space as early as 2011, shortly after the Affordable Care Act was passed. Decided at the time it wasn't right, both for J2, but also, we felt it wasn't right because there was a lot of moving pieces driven by the Affordable Care Act and some downstream regulations that, in fact, had not even yet been written. But by about 2017, we saw that there was an opportunity, so we started to invest at $75 million, $80 million that I mentioned. We started to put additional dollars to work in the digital fax business unit such that it could be regulatorily compliant for the health care industry. And we started to observe that with the development of APIs. Not only do we have the opportunity to just replace, with a better solution, the fax that was on-prem, primarily in the form of servers, but in some cases, even stand-alone machines or multifunction devices, but we also had an insight into interoperability. And interoperability is just a big fancy term to say, how do you seamlessly move documents and information through the health care system, meaning patients, doctor, specialist, lab, payer. All of these that when you get into the system, have a right or a need to this information. But because the EHRs are very siloed, it can be very difficult to extract that information if you happen to be operating across multiple EHRs. One of the things that is common to all of those is that they send and receive faxes. So it became an insight for us that, that could be a core beachhead for us to make a legitimate play to enter the health care space. Because quite frankly, you say, "Well, who are you guys? You've been doing finance and you've been doing legal, and that's all right, but you don't really have a base of customers, you don't have those reference accounts to help them," and that is true. So we started to make the investments in the technology. We started to evolve the team. It was not an accident that about 3 years ago, in June '18, when there was an opportunity to really, for the first time, put in place a head of the digital fax business in J2, we chose someone that came from the health care space, John Nebergall. We'll get into his [ D bio ]. It was addressed briefly on April 20, when Vivek and I first talked about the spin. And there's a page in that deck that outlines the core of the senior management team at Consensus going forward, but it does not come from the fax business. When we looked at who do we put it in, do we bring someone from health care, if we think in the future or you bring someone from the fax space. We chose someone from the health care space. So John has been very insightful in terms of how to evolve the product. Now we have 2 new products in today, one is called Consensus Unite and one is Consensus Signal. It's been fairly recently launched. I'll spend more time talking about Unite. So Unite, as the name implies, brings together the core pickup compliant protocols for the movement of medical information: fax, which is a core strength of ours, direct secure messaging, and HL7 and 5, which are really technologies for the movement of data. So we have it bundled under 1 platform, and this is fairly unique. There aren't a lot that are offering interoperability as a service and bundling all of the protocols in 1 common platform. We actually are agnostic which of those you use or the proportionality in which you use them the way that the pricing works for the sale of that service. Now we have customers in both camps, meaning we have those that before the release of that product, which really didn't gain traction till late last year because of the pandemic. We released it technically in March, right as the pandemic was rolling out. But because it is a product that requires sales, really, we didn't start selling it till probably September, October last year. So it's fairly nascent as a product within the Consensus company. So we have those that we've sold just the fax replacement, and we have sold -- those that we've sold the Consensus bundle. And I'd say that right now, we're somewhat indifferent between the sale of 1 or the other because for us, it is really continuing to add to our overall customer base in the health care space. And for those that take fax only, it gives us an opportunity over time to then educate them on Consensus Unite and Consensus Signal. Just to give you a sense of the impact we've had in just a few years, our corporate business today is about $160 million in revenues. So as Jon pointed out, it is rapidly catching up to the web business, and we'll probably surpass it within the next couple of years, given that it's got a high single to low double-digit growth rate organically and about 60% of that business today is helpful. And most of the growth is being driven by the health care customers, which are growing -- they're growing double digits. They're growing into the teens. And then we have a smaller piece of that bait, which still are those other categories such as finance and legal, that they're growing around mid-single digit. So we're very excited about what's going on overall in our corporate piece of business, but really the focus is on the health care piece; it is what is driving the growth. But I just would note, and we develop solutions and technologies for health care. I do expect that we will adapt, where appropriate, some of those solutions or other industry verticals. So our sales team that do cater to these other industries like the finance industry, we're not going to just cordon off the product and only reserve it for health care if there is some applicability in other industry.

Great. That was a lot of detail. I know you touched upon the point that you're kind of agnostic whether your customers use fax or not. But I wanted to talk a little bit about fax itself because people have this -- maybe it's a misperception that it's a dead and dying format. I know it doesn't matter as much to you, but the data actually shows that fax is -- it's still growing as a medium for transmission. Age is transmitted, going up every year. What's causing that? And what gives you confidence that people will still use that and give you that entry point into [indiscernible]?

Yes. I think we got a few things driving it. One, clearly, in the health care space, and there was a slide in the April 20 presentation that measured it a little bit differently. It didn't talk about fax phase, it talks about data or exabytes of data, and it's a 15x growth rate over the last 7 or 8 years. So what do you have going now? Well, first of all, you have an aging demographic, which generally gets more health problem. You have an increase in specialization. So now we just don't go to our general practitioner. We've got the heart doctor, the knee doctor, the orthopaedic, all the specialists that are part of the system. Well, all of those interactions and all the tests that they run create more and more and more data. And so the challenge really is, well, how does all this data get organized? How do we put all together so that a given physician has a holistic profile of you, the patient? And particularly, as I mentioned earlier, if you're seeing different providers, that data in the first instance may be stored in a very different format and in a very different system. I also think that why the fax tend to continue to be predominantly used, there's a couple of reasons. One, of course, is that it is HIPAA compliant. And I would just note, we say HIPAA compliant, our service on the fax side, we actually went 1 step beyond. There's an institution called HITRUST that comes in and they validate. They're a third party. They test and they validate our solution and declare it to be HITRUST certified, which by implication means HIPAA compliant. So first and foremost, you have a narrow set of protocol in the health care space with a movement of information because you don't want to fall out of HIPAA compliance. Secondly, you have the longevity factor. Fax has been used in the health care industry for a very long time, not dissimilar from other industries. And it is probably the easiest of the current protocol that a HIPAA-compliant is to you. So all of those things sort of push in the direction of perpetuating that kind of behavior. And then as I mentioned earlier, it has an added benefit today of being able to communicate across the HR systems, meaning an Epic system talking to a Cerner system as opposed to the documents or data that are stored in Epic and Cerner that don't directly speak to each other, but they can through that fax, if you will, sort of backdoor protocol. So for all of these reasons, fax is huge. Now there are things like direct secure messaging and there are instances where Direct Secure messaging actually has some advantages over fax. Think of the transition of images. So you think of x-rays and MRI, if you don't have the physical documents, you don't have it on a CD-ROM, you would probably want to send those digitally through direct secure messaging because there would be less degradation of quality of the image. But those are 1 of the reasons why we like the bundle concept because you can actually parse out use cases and say, "Hey, for this use case, you should use direct secure message. For this use case, you're agnostic; use fax. It's easy and it's quickest to use that protocol. If you only want to select data, you might want to use the HL7 FHIR technology."

Got it. Okay. Give us a sense of the competitive landscape out there. You're coming to the arena of traditional EHR EHIT players. But also you're competing against legacy SaaS solutions as well. Just tell us what makes your product better, how easy of an argument it is to make to convince people to switch over to you.

Yes. So there's different layers of competition because different entities have different approaches to either the problem as a whole or they want to nibble at a specific piece of the problem. So we do have those that are in the cloud digital fax space. I would say, today, those that are making an attempt at health care and have the ability to provide the underlying services and they're robust enough as a company. Clearly -- and we compete with them in other enterprise situations would be OpenText, a public company out of Canada. There's some smaller U.S.-based [ trida ] companies such as DISCOM and Concord Fax. They would tend to be focused on, I'll call the fax replacement solution. So they're not delving into these other technologies. There's not a bundled concept, it's fax or fact. Then you have companies that are involved, trying to attack interoperability, but generally focusing on a specific protocol. So you have the HIFs that are involved in direct secure messaging. You have those that are interface companies like an InterSystems or interface or integrators such as Redox or Philips or even the connected EHRs like Epic and Cerner. Most of them, though, tend to be focusing on HL-7 and 5. Now we talk about the bundled solution, combining the protocols and offering it as a service, we found 2 smaller competitors. And interestingly enough, we are collaborators with each of them. One is a company called [ No To ] and the other a company called Updox. And so it's one of those interesting spaces where you're sort of competing; on the other hand, you also have a degree of cooperation with them. So as I say, we're competing at different levels against different providers. One of the advantages that we see is making decisions simple for the purchaser to instead of having a multiplicity of providers, each having a strength maybe in a given protocol to buy into the platform and have access to all the protocols.

Great. Just wanted to touch on the Webfax piece or I guess you didn't call itself on that, you mentioned earlier in the call. You plan to have that business to grow compared to the declines that we've seen over the past couple of years. What makes you think you can do that now compared to what was happening under J2?

So first of all, it's already happened. So you're correct. For a long time -- and look, I'm the CFO sitting at the parent during those years -- when you're running this portfolio, a lot of different pieces. Remember, Webfax is a piece of a business unit in J2. It's not even its own business unit. I think that there was a view that, look, it's individuals, the future is really in corporate, the teams that were running it over the years were always sort of low single-digit, like 2%, 3% decline. And I think, look, when you're running a lot of different businesses, you say, okay, if you think that's the best you can do -- and by the way, you're limited in your marketing dollars -- then you accept that. And as long as you perform at that level, you move on. Few things have changed even under J2's ownership. One is the work pattern because of the pandemic. I think for a large portion of the workforce that we go after are not going to change, meaning we don't see even our own company, most people returning to 5 days a week in the office. This concept of a hybrid model or working remotely, working from home, is going to persist in many of the primary industries that we cater to, where you don't maybe need to be at an office every day, 5 days a week. But what does that necessitate? The need for a bunch of protocols that people that have affordability that they can use when they're in the remote location and not on-prem in their office. So I think those will continue. We saw some, I think, kick up in the early stages of the pandemic when there was the mass work from home movement. But we've seen even as recently as Q4 and Q1, where you could already get the pandemic starting to wane, sustained modest growth of about 1% out of the Webfax business. I also think, too, we made a management change, which I believe has been helpful with greater depth and expertise really in the online market. So right now, we're not expending really any more dollars than we normally would in terms of our marketing efforts for Webfax, but we've gone from that minus 2, minus 3 to a plus 1%. Now when Consensus is independent of J2, one of the things that I've already told the leader of that team is, I want to aggressively try additional forms of market. I'm willing to spend more money if that can grow 2% to 3%. Now if it turns out that after those tests, you can't move the needle more than 1%, then fine, we'll dial back from our marketing, and we'll spend at the current levels and take the 1%. But I think there is untapped demand out there. I think once again, the emphasis of focus. I think the willingness to just invest and spend some more dollars. I also would add that the enhancement of the product, we actually -- you don't even know. I'm sure Jon, you don't even know this. We've launched a real digital signature in beta right now called JSON. And JSON is something that will be added to the SoHo product, as well as getting a digital fax number. And all the things you can do through that protocol, you'll also have a more robust digital signature. We have a very lightweight one right now that's part of, say, the EPAC solution. So one of the things that I see within the SoHo market is us taking some of these other technologies that we've developed primarily for other purposes and bringing where appropriate them into the bundle at the SoHo level. And not using that as a method necessarily to raise pricing, but more as a need of building the customer base and retention. So those are things that are already starting but we'll look for those to accelerate over the next 2 to 3 years.

Got it. Just give us an update on the timing of the spin. Is it still on track for Q3? Tell us a couple of milestones on that, #1. And #2, if you could touch on both consensus and J2, what will the capital structures look like on the spin you see now?

So we still expect it to be Q3. There's a small chance that it could be in August, but one of the contingencies prior to spend is that Consensus raises some debt. So I think there's an increasing belief that unlike last year, the last 2 weeks of August and probably early September through Labor Day will be more application time for people. So that limits the window in which pre-Labor Day Consensus can go raise debt, and Consensus needs to raise that debt within a few days of the actual spin occurring. So the things that we are sort of in process and waiting for are SEC comments on our Form 10 and the response to those comments and see how much back and forth there will be; likely the inclusion of our June financials into the Form 10 and also to be used for the marketing of the debt consensus. Those things we need to believe that those activities probably take place sometime after Labor Day, meaning that the close of the transaction is anywhere from mid-September through maybe as late as the end of September. But there are these dependencies, not all of which are in our control. So this is kind of how we map it out right now. But as I say, the SEC takes longer or various things like that occur, it could push us to the latter portion of that time frame. If things move more expeditiously, it could be at the earlier stage of that time frame. In terms of the capital structure of the 2 companies, we are -- I'll deal with Consensus because it's the simplest. There's about -- expected to be about $200 million of EBITDA after corporate expenses are pro forma in for a full fiscal year. And so the view has always been that Consensus will be [ 11 to 4x ] to a rate by $800 million of debt. Of that $800 million, it will keep $60-some million in its cash on the balance sheet. There are some fees and expenses that we paid by Consensus. And then about $725 million will transfer back to J2. Now J2, that money, if it's used for debt retirement, can essentially be tax-free. As you know, we called the 3.25% converts; those converts will settle on August 2. We've chosen a net share settlement method. So the first $400 million will be paid in cash and in essence, netted against the $725 million over. We'll issue shares for the remainder of the value of those 3.25 converts. And then J2 will take the balance of the proceeds, roughly $325 million, and retire either a portion of the 4 5/8 notes for the 1.75% converts. Now neither one of those are callable, so they will have to be under a different structure. But what should happen when the day is done is that J2, through the retirement of the 3.25% converts and the additional paydown of $300-some million coming over from Consensus, it should be left with about $1 billion of debt, and that would result in a leverage ratio sort of pro forma for the spin of slightly in excess of 2x leverage. So it actually becomes a deleveraging event for J2. And Consensus, of course, they, one, will be at 4x leverage with the goal over time as the EBITDA increases, they'll be at deleveraging. And then there is a prohibition for the paydown of debt for the first 2 years. But after the second year of the spin occurs, then my sense is that depending on the rates 2 years out, there'll likely be a refinancing of at least some of the Consensus debt and a further lowering of the leverage ratio.

Got it. I think we only have time for 1 more, so I just want to sneak 1 in on the remaining income. You recently announced the acquisition of Moz. Tell us a little bit more about what that piece does and what it brings to the table? And does this trade a new business unit for you? Does it make you a consolidator in the Martech arena?

Yes. So we're really excited about this deal. It's a company we've looked at over a number of years. It's really a leader in SEO optimization for small- to medium-sized businesses. As you know, we've talked about our e-mail marketing businesses of iContact and Campaigner evolving and going beyond just pure e-mail marketing. We do have some other services that are part of the Martech group. This still is a big quantum leap forward. It's a great brand. We've got a great team coming over. It really does extend the product portfolio into serious SEO optimization, which is what Moz is known for. So there's going to be -- look for some rebranding of our whole SMB enablement business unit over the coming months. I think to your point, it really does aggressively move us into the whole Martech arena because this really is about managing all of your ways that you can spend and market for these SMB companies. And I think, yes, just like we've done on e-mail marketing side, it strengthens our position to act as a consolidator, not only in the area of e-mail marketing and SEO optimization, but in other categories that would fall under the Martech of products. So it's a very exciting time. We do have integration to do. So like a lot of the business units in J2, the primary focus right now will be the integration of Moz with the rest of the Martech business unit. I expect that to take sales several months, but probably as we exit this year and into early next year, that should be substantially complete. As usual, we continue to look for other ideas in this space, but we'd probably be a little bit cautious about transacting until we get later into the year.

Fair enough. That's all we have time for folks. Scott, I don't know if you had 1 or 2 sentences closing.

No. Just I appreciate everybody's time. I think we've got 2 great companies coming here. I remain very excited about we call the main core future of J2. I think it's well set up for the future. Obviously, I'm excited about the Consensus opportunity, and we've had some limited time to talk about it. We will be -- as we get closer to the spin date, doing non-deal roadshows, both on the equity side, give a deeper dive and introduce more of the management team. Obviously, there will also be a couple of days of marketing when we go raise the debt and then sometime likely in September, the separation occurs, and then we would be off on our own and be looking forward to continuing the dialogue both with you, Jon, but also potential investments.

Great. Thank you, everybody.