Consensus Cloud Solutions, Inc. Q2 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to Consensus Q2 2022 Earnings Call. My name is Paul, and I will be the operator assisting you today. On this call from Consensus will be Scott Turicchi, CEO; John Nebergall, COO; Jim Malone, CFO; and Adam Varon, Senior Vice President of Finance. I will now turn the call over to Adam Varon, Senior Vice President of Finance at Consensus. Thank you. You may begin.

Good afternoon, and welcome to the Consensus Investor Call to discuss our Q2 2022 financial results, other key information, and reaffirmation of our 2022 guidance. Joining me today are Scott Turicchi, CEO; John Nebergall, COO; and Jim Malone, CFO. The earnings call will begin with Scott providing opening remarks. John will give an update on operational progress since our Q1 investor call, and then Jim will discuss Q2 2022 financial results and 2022 guidance. After we finish our prepared remarks, we will conduct a Q&A session. At that time, the operator will instruct you on the procedures for asking a question. Before we begin our prepared remarks, allow me to direct you to the safe harbor language on Slide 2. As you know, this call and the webcast will include forward-looking statements. Such statements may involve risks and uncertainties that would cause actual results to differ materially from the anticipated results. Some of those risks and uncertainties include, but are not limited to, the risk factors outlined on Slide 3 that we have disclosed in our 10-K SEC filing as well as a summary of those risk factors that we have included as part of the slide show for the webcast. We refer you to discussions in those documents regarding safe harbor language as well as forward-looking statements. Now let me turn the call over to Scott.

Thank you, Adam. This was a very good quarter in light of high inflation and the risk of an impending recession. We were able to produce a record quarterly revenue by growing 6% versus Q2 2021. In addition, we continue to operate at healthy EBITDA margins of 54%, at the high end of our stated range of 50% to 55%. These results were driven by continued strong performance by the Corporate business, which grew 17.1% versus Q2 2021, and I would note, 11.1% organically. In addition, this is the eighth consecutive quarter of Corporate revenue growth and its eighth straight quarter of ARPA growth, up more than 19% versus Q2 2021. With Clarity tracking to produce revenue in Q3, additional features in jSign, the introduction of Unite Lite, the integration of certain of Summit's technology resulting in Consensus Conductor, the Corporate channel is well positioned for continued growth driven by the revenue from the health care sector. All these initiatives, including our core digital fax product, have produced significant momentum in our Corporate channel, and we have a rich pipeline of opportunities for the second half of 2022. Our SoHo channel had a good result in light of three factors impeding its performance in Q2. First, early in the quarter, a geo compliance regulation in Japan resulted in the cancellation of approximately 3,500 accounts. Also during the quarter, we began to test a price increase to new customers and a portion of the SoHo base, which was done in lieu of directly charging state sales taxes. Finally, currency headwinds continued affecting the Q2 results by approximately $1.1 million versus Q2 2021, most of which is allocable to our SoHo revenue streams. We believe these FX headwinds will continue throughout the year. However, the other two factors are substantially behind us. Jim will provide more detail on the financial performance for the quarter as well as for each channel of revenue. We made significant progress on the ECFax system for the VA. We continue to work with Cognosante and the VA and expect authority to operate by the end of September. Initial rollout is scheduled for late September or early October. I would note, we do not expect this rollout to contribute meaningful revenue this fiscal year. As we stated last quarter, we are also seeing additional early interest from other federal government agencies. John will provide additional details on each of these areas in his portion of the presentation. Despite the tight labor market, we have continued to make progress in our overall hiring with a focus on our technical team and filling out our staff as a stand-alone company. We ended the quarter with 540 employees, and I would like to welcome all of our new employees who have joined us since the last earnings call. As we come to the 1-year anniversary of the spin, we have substantially completed the separation from Ziff Davis, our former parent. We made a payment of $11.5 million during the quarter for fees and expenses related to the spin and Ziff cash that we were holding. We expect a final payment before Q3 quarter end. In addition, during the quarter, we assisted in the marketing of 2.3 million shares or about 58% of Ziff's holdings in Consensus. This transaction was beneficial to us in several respects. First, it eliminated a large piece of the Ziff overhang on our stock. Second, it allowed us to market the Consensus story in a manner similar to an IPO. And third, it provides us the opportunity to gain additional research coverage. While the sale of this large amount of stock put temporary downward pressure on our stock price, we were able to take advantage of this opportunity by repurchasing in the open market approximately 189,000 shares at an average cost of approximately $40 per share. Before handing the call over to John, one final thought on the economic environment. As I mentioned at the beginning of my comments, the economy remains fragile with high inflation and a recession that is either upon us or just around the corner. We remain liquid with more than $75 million of cash on our balance sheet and the undrawn line of credit that we put in place last quarter. We remain well positioned for these weakening economic conditions due to the fundamental necessity of our services, the subscription nature of our business, which has approximately 70% fixed revenue, and the increasing percentage of our business that maps to the health care space. We remain confident in our business prospects and reaffirm our financial guidance for 2022.

Thank you, Scott. I'm excited by the performance of our corporate sales program delivering another record quarter and bringing in $5.2 million in ACV and license bookings. As you recall, our corporate sales team is comprised of enterprise field sales, an inside sales team focused on small and medium businesses, and the channel program targeting telcos, EMRs, and resellers. Sales bookings for Q2 grew 4% over Q1 and represent a 41% increase over Q2 of last year. Leading the way was our enterprise sales team who closed major fax deals with CoverMyMeds, a large national medication prior authorization service provider, and with 3M. The Unite sales team also had an impressive quarter, delivering a 43% increase over Q2 '22. The pipeline is strong in cloud fax, jSign, and Clarity. Our advanced products accounted for 20% of our quarter sales volume. The SoHo channel faced pressure on several fronts as a number of events impacted the business. Domestically, we executed a price increase as part of our plan to address the sales tax remittance project we mentioned last quarter and saw accelerated churn as notifications were sent out as well as a dip in new accounts, both within our range of expectations. In Japan, which is our second largest SoHo market, a strict geo compliance regulation on phone numbers forced us to terminate a number of accounts and resulted in a churn rate that was 250% greater than the historical rate in Q2 but has since returned to normal levels. Generally, we are seeing increased levels of credit card declines primarily associated with new decline codes that disrupted our normal decline recovery process. While overall churn rates are trending back to normal levels, it remains moderately elevated. Finally, we are executing a targeted account-based marketing program to upgrade SoHo health care customers to corporate SMB products. And while that is an overall benefit to the business, SoHo account levels are impacted. The channel program has continued to deliver, accounting for 15.3% of overall corporate revenues and signing a partnership agreement with Spectrum UCaaS this quarter. Interest from telecom providers continues to accelerate with the implementation of FCC Order 19-72A driving traditional POTS or Plain Old Telephone Service copper lines out and replacing it with voice over Internet protocol or VoIP service. The Consensus Cloud system is in a strong position to be the de facto replacement, and telco providers continue to be a very active part of our pipeline. Progress on ECFax is on schedule and has been certified as an in-process FedRAMP vendor. This is the final step before receiving authority to operate, or ATO, and is solidly on target for our September go-live as planned. As an in-process vendor, ECFax gets listed on the federal-approved vendor registry. And as a result, there have been three other federal agency inquiries to explore the use of the system. We have been working on our first implementation of Clarity and expect that delivery to be complete in Q3. The experience is invaluable for our implementation team, and we are already developing best practices that will improve our deployment process for subsequent engagements. Clarity's capabilities were expanded to include intelligent handwriting extraction with a late request from our customer under implementation. Based on customer feedback, we have launched a lighter version of Unite that caters to practices that do not require workflow or patient record query capabilities. The release was late in the quarter and did not impact Q2 results. The product and engineering teams have been focused on the VA project as well as some key enhancements to both jSign and Clarity. We successfully launched the multi-document envelope capability for jSign in Q2, delivered the ability to interchange a document between fax and digital signature, and began work to have jSign join eFax as a HITRUST certified platform. I'm pleased to report that the technology integration of fax into the Summit Exchange interface has been renamed Conductor. The Conductor platform has also been expanded to execute complex routing rules for fax, HL7, FHIR, and direct secure messaging. Overall, the operating progress in Q2 was substantial and in line with our 2022 execution plan.

Thank you, John. Moving to Slide 7, corporate revenue. Q2 2022 corporate revenue of $49.1 million increased $7.1 million or 17% over the comparable prior year period. Corporate revenue grew $7.4 million or 17.8% on a constant dollar basis. The number of accounts at 46,000 was flat year-over-year. However, taking into account MyFax migration, which began in Q2 2021, we were actually up 2,000 accounts or 4.1%. Average revenue per account increased by $58.53 or 19.6% over the prior comparable period, primarily relating to increased usage and new larger customer acquisitions. Paid adds of $4,000 or 13.7% increase over Q2 2021, also contributed to the corporate revenue growth. Monthly churn of 1.88% was favorable to Q2 2021 by 126 basis points. Churn was virtually flat if we normalize the Q2 2021 for MyFax migration. Moving to Slide 8, SoHo. Q2 SoHo revenue of $44 million or negative 4% to the comparable prior quarter was impacted by a negative foreign exchange impact of $800,000. Measured on a constant dollar basis, results would have added negative 2%, in line with our expectations of negative 1% to a negative 3%. The number of accounts in the quarter compared with the comparable prior period decreased by 6.6% or 72,000 accounts. Sequentially versus Q1 '22, the base declined 26,000, primarily related to the geo compliance, new credit card code decline protocols and notification of price increases. Paid adds were down 12.8%, and year-over-year churn was unfavorable by 67 basis points. However, average revenue per account increased 1.5% or $0.19 driven primarily by increased average variable usage per account. As stated in Scott's opening remarks, effective in the third quarter, we are rolling out a SoHo price increase to a portion of the SoHo base, which was done in lieu of directly charging state sales tax. Moving to Slide 9 for our Q2 results. Q2 revenue of $93.2 million was $5.4 million or 6.1% favorable to the comparable 2021 quarter. However, considering the foreign exchange fluctuations compared to last year, Q2 2022 grew $6.5 million or 7.5% on a constant dollar basis. We ended the quarter with a cash balance of $76 million. As discussed in prior quarterly calls, Q1 and Q3 are the stronger cash-producing quarters as they are not burdened by semiannual interest payments of $26 million paid in Q2 and in Q4. Moving to adjusted EBITDA. Q2 EBITDA of $50.3 million was favorable by $300,000 or 60 basis points compared to the comparable prior period. As footnoted in Q2 PowerPoint deck distributed today, 2022 results reflect actual costs where the prior periods have been consistently presented on a pro forma basis including stand-alone public costs to facilitate a basis of comparison. Q2 adjusted EPS of $1.45 was $0.09 or 7% favorable to the prior comparable period using a share count of approximately 20 million for both periods. Moving to guidance. As noted on Slide 10 of the PowerPoint deck, we have provided guidance of revenue, adjusted non-GAAP EBITDA, and adjusted non-GAAP EPS. We anticipate that our full year results will be within the guidance ranges provided in the schedule.

The first question is coming from Jon Tanwanteng from CJS Securities.

This is Dan Moore filling in for Jon. I appreciate all the insights. Could you discuss the assumptions regarding foreign exchange rates, wage inflation, and general inflation that are supporting your reaffirmed guidance and where we currently stand within those ranges?

Yes. Each quarter, we review the foreign exchange rates. Historically, currency fluctuations haven't significantly impacted the company, but the euro and the Japanese yen are notable exceptions. As of the end of the June 30 period, the exchange rate for the euro was nearly 1:1, and for the yen, it was about 0.0072. We assume those rates will persist for the latter half of the year, even though they will likely fluctuate. When we did our original budget and announced our guidance in February, the two subsequent updates on foreign exchange had a negative impact, resulting in a headwind of approximately $2.8 million since our original budget. Of this, about $2.1 million affects SoHo and around $700,000 impacts corporate. Half of this headwind is due to historical factors because we've passed the six-month mark, and there is also a portion that is prospective. We don't hedge our currencies in terms of revenue or profit, so we are subject to the impacts of foreign exchange. This does affect our profits, as we have costs in euros and yen, but we remain very profitable, with an approximate 50% contribution to EBITDA that reflects the varying accuracy of our currency assumptions. Regarding wage inflation, we've observed two significant trends over the past six months. At the start of the year, we had an ambitious hiring plan focused mainly on our engineering and technical team, which we refer to as Genesys, representing a revitalization of our technology efforts, much of which you've heard John discuss in previous calls. Although we're somewhat behind in terms of hiring, the costs associated with hiring new talent and our existing staff are higher. Consequently, we've outpaced our cash outlays for employee costs in the first half of the year, but we haven't fully met our hiring targets. Looking ahead, we plan to continue hiring and aim to add another 60 to 70 employees. While that might be an ambitious target, it's included in our forecasts for the second half of the year and its contribution to our full-year guidance. Overall, despite the various challenges, we are tracking towards the midpoint of the guidance range that Jim provided and that we've maintained since February.

Very helpful. And if I sneak one more in. Just any additional color you might have on the expected ramp of the VA project? I know minimal this year, but what are your expectations as we start to think about '23?

Yes. We'll know, I think, a lot more when we talk again in November, we've had the Q3 because, as John mentioned, we are knocking on the door. It's kind of a quiet time of the year for federal agencies now that we're in August. But once September kicks in, we're expecting to get that authority to operate, certainly before the end of that month of September, the end of our quarter, the end of the government's fiscal year. We actually think we may be able to see a rollout in just around quarter-end for us, which means there will be some revenue production in Q4. It's unclear to us even right now how to estimate it. We do think that, that piece will be de minimis. So it's not really formally contemplated in how we're thinking about Q4. Quite frankly, Q4 is really important for us to understand the rollout as we look forward into '23 and as we prepare our '23 budgets and ultimately our '23 guidance. But I think I'd be shocked if we got $100,000 of revenue in Q4, somewhere between tens of thousands to $100,000. So clearly, not relevant to us, not important in terms of our overall thinking, but it is the on-ramp to what then I think will be more meaningful revenue in '23, but we're not quite ready to disclose what that is because we've got to get a little bit more work done.

And the next question is coming from Ian Zaffino from Oppenheimer.

This is Isaac Sellhausen on for Ian. Just first question on the SoHo business. Could you just talk about the level of price increases that will be implemented and maybe just remind us if there has been a typical cadence of price increases in the SoHo business in general?

In response to the second question, there hasn't been a price increase in many years. Historically, price increases occurred roughly every three years from 2000 to 2008, amounting to three changes in that time. The approach we're taking now is quite different from what happened previously. The recent price change is primarily intended to address the sales tax accrual issue rather than to increase revenue or profit. Last year, in the fourth quarter, we booked an $8.6 million accrual for several years of sales tax owed to various states because we had previously not charged or accrued for it. This year, we had to find ways to address it, particularly for our SoHo channels. One option was to modify our billing process to accommodate each state’s sales tax, which would be complex and time-consuming. The other option was to raise prices. In response to your first question, we have varied pricing in our SoHo channel with a price increase of between $1 and $2, but it won't impact all customers. It's important not to assume $1.50 across a million customers, as around 10% of those customers are outside the U.S. and won't be affected. The price increase aims to handle various elements rather than generate additional revenue. Of the remaining customers, approximately a third will experience the price increase, while we expect some will cancel their services. This adjustment is projected to yield about 2% in revenue this year, which interestingly offsets the foreign exchange challenges in SoHo. Additionally, around 20% of our customer base consists of annual customers who will be affected by the price increase upon renewal over the next year. There’s also a third that remains exempt due to being new customers or already participating in premium programs. Therefore, when calculating potential revenue, you should expect a few million dollars in benefit this year, which will likely increase next year as we account for a full 12-month cycle, yielding a revenue boost in the low to mid-2% range.

Okay. Great. That's very helpful. And then just a quick follow-up in terms of the full-year revenue guidance that was reaffirmed. And I guess could you provide some color around the original 17% to 20% growth in Corporate revenue? I guess it seems that the strength in Unite and Advanced Products is driving some of that growth already. I guess what other areas have been strong? And how has that sort of played out compared to your expectations from the original data of the guidance?

I'll provide a general overview and then ask John to share more detailed information. Overall, I believe there are three main factors driving revenue growth in the Corporate Channel for 2022. First, the core digital fax business remains the primary driver due to its significant size and its expansion into the healthcare sector, where we are acquiring new customers. John mentioned some of these customers, but there are many others in our SMB channel that may not be as recognizable. Continuing to capitalize on this pipeline of opportunities, whether smaller SMBs or larger enterprises, is crucial and was a key factor in our budgeting expectations. Second, we have the Advanced Interoperable Solutions category, including Unite, Clarity, and jSign, as well as some services from our Summit acquisition. However, the Summit piece is smaller. As John highlighted, we've made significant progress with Unite this fiscal year, to the extent that we created a simplified version called Unite Lite for certain customers who found the full functionality overwhelming. Clarity, while not generating revenue yet, is expected to do so soon in Q3. This is mainly a timing matter, and we are seeing positive developments with a specific customer helping us enhance the product. It's a mixed situation because while it delays revenue, it also strengthens the service. Therefore, I would identify these as the two main drivers. It's worth noting that we didn't allocate any budget for the VA this year, so we will see limited revenue from the Q4 rollout.

Yes. And I also say that when you think about the opportunity to grow in corporate, I think we have a very solid and predictable operation in our inside sales team in the way that they're able to perform quarter in and quarter out. I think when you get to field sales just by the nature of the kind of sale it is, it tends to be lumpy. So you can very quickly have a big customer come in and change things for you. You can have those kind of pops that are great to have. And as I look at our pipeline and the advanced state of a few of the opportunities in that pipeline, we have a positive outlook on the balance of the year because we know that we have solid performance coming from that inside sales team, and we feel confident that we're going to have some of these opportunities that are in the pipeline materialize.

I want to make one additional comment that relates to your question but also provides a broader perspective. We are noticing that with the Advanced Interoperable Solutions, particularly beyond cloud fax, there is a ramping effect in how we acquire customers and how revenue flows in. Looking back at the history of Unite, which was launched during the peak of the pandemic in March and April of 2020, we've seen a consistent ramp up despite that challenging environment. This pattern is realistic for our new service releases as well. When Clarity launches, there will be a period for customer acceptance, during which we will gather feedback and enhance the service before we see revenue growth. I believe this pattern will also apply to Harmony. We anticipate some minimal early revenue from Harmony in early 2023, but we expect significant growth to occur in late 2023 and into 2024. This expectation is due to the complexity of these solutions, which require more integration with various company systems and involve regulatory compliance considerations such as HITRUST certification. However, I am very positive about our portfolio and the success our sales teams are experiencing in both inside and field sales.

With the price increase on the SoHo side, is that pass-through revenue? Or is there a margin on that revenue?

There will be some variability depending on where we land in that range. Focusing on this year, there could be a beneficial margin next year, and the key question will be how we utilize that margin. This year, we're anticipating a few hundred thousand dollars in benefit, but our intention is to reinvest that. Looking at the latter half of the year, we've budgeted approximately $600,000 to $700,000 for increased marketing spending. Additionally, we're continuing to ramp up hiring. If we project $2 million in revenue, it would offset the $1 million in foreign exchange impact, leaving us with an excess of $1 million. Our plan is to reinvest this entire amount in a mix of personnel and marketing. The actual outcomes will depend on the effectiveness of our marketing investments and our hiring pace, which we'll evaluate as the year progresses. As we look forward to next year, we anticipate revenue exceeding the sales tax owed, and this will be a topic for discussion when preparing the budget. Following our spin-off, we were under-resourced in terms of personnel. We have a plan that avoids rapid hiring to prevent overwhelming the company and financials, instead spacing hiring over a couple of years. We will take a close look at how many people we can realistically bring on in various departments as we approach 2023. We're also considering hiring beyond technical and general administrative roles to strengthen our sales and marketing teams, which will lead to further discussions. While we may not see the impact on the bottom line aligning precisely with our forecasts, it is crucial to understand we need to position the company for the significant opportunities ahead over the next few years. Our focus is not just on the immediate quarter or year but on right-sizing each department to capitalize on the opportunities before us. Although John briefly mentioned it, there is growing interest from other government agencies in our ECFax solution, which we anticipated. We currently have the resources to support the Veterans Affairs Department but not enough to cover the entire government revenue channel, which has implications for our strategy. Thus, our primary focus is not to chase incremental EBITDA at the expense of our long-term goals; however, if our expenditures do not yield effective results, we will reconsider the allocation.

Okay. And then just what's the difference between Unite and Conductor? Like is there different use cases or different target customer segments for the two products? Or can you just help me understand that a little bit better?

Absolutely. You can view Unite as a central hub for sending and receiving faxes, secure messaging, and utilizing advanced tools to retrieve patient records in specific locations, while also applying workflow rules to incoming faxes and secure messages. It can be used with or without an EMR, allowing it to integrate into an EMR and function as a communication center or operate independently, managing the flow of information in and out of a practice. When considering Conductor, think of it as a tool that enhances an EMR's ability to communicate effectively. EMR systems installed nationwide need to interact with other EMR systems or agencies like the CDC or state boards, which they achieve through an interface. Conductor serves as an interface that goes beyond standard healthcare interfaces, which typically handle HL7 and FHIR messages. It also facilitates secure direct messaging and faxing, allowing for more complex routing commands for any information sent or received. In summary, Conductor is a comprehensive solution designed to work alongside an EMR, while Unite is a more straightforward tool that can assist smaller practices in managing their information flow efficiently, regardless of their EMR status.

And there were no other questions from the lines at this time. I would now like to hand the call back to Scott Turicchi for closing remarks.

Thank you, everyone, for joining our Q2 earnings call. We issued a release a few days ago. Tomorrow, we will be participating virtually in the Oppenheimer Conference, where John and I will provide an overview of the company and discuss our financial results. Ian will also lead a fireside chat Q&A session. Additionally, there is a conference organized by Wells Fargo, which is primarily aimed at bondholders, scheduled for early September. As we have more conference opportunities, we will announce them publicly. We are currently expecting to release our Q3 results and hold our Q3 earnings call around the second week in November, approximately the 10th, although this date is not yet firm. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference. You may disconnect at this time and have a wonderful day. Thank you for your participation.