Consensus Cloud Solutions, Inc. Q1 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to Consensus Q1 2023 Earnings Call. My name is Paul, and I will be the operator assisting you today. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. On this call from Consensus will be Scott Turicchi, CEO; John Nebergall, COO; and 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 Q1 2023 financial results. Other key information and reaffirmation of our 2023 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 year-end investor call, and then Jim will discuss Q1, 2023 results and 2023 guidance. After we finish with our prepared remarks, we will conduct a Q&A session. At that time, the operator will instruct you on 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 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 slideshow for the webcast. We refer you to discussions in these documents regarding safe harbor language as well as forward-looking statements. Now let me turn the call over to Scott.

Thank you, Adam. I would like to provide a brief overview of the quarter before handing the call over to John and Jim for details on our operations and our Q1 financial results. Q1, 2023, was a record first fiscal quarter with revenues of 91.5 million and an all-time record for our fax volumes. Our revenue was in line with our expectations, representing approximately 24% of our annual expected revenue at the midpoint of our guidance for the year. And consistent with our disclosure during the Q4 call, the corporate channel experienced 6.2% growth consistent with the organic performance in Q4 of 2022. Despite this growth, we continue to see slow decision-making by our largest prospects and slow implementation by those under contract. This is driven by uncertainty in the economy and labor shortages that exist, especially in the healthcare space. As we've stated before, we believe that this will continue throughout 2023, and our previously released guidance has taken that into account. The price changes for SOHO are coming to an end in this current quarter and continue to perform within our model expectations. During the quarter, we had to file both an amended 10-Q for Q3, 2022, as well as the late 2022 10-K. The amended 10-Q delays and filing, along with additional audit work, had an incremental cost of $2.3 million more than in Q1 of 2022 and had an impact on our EBITDA margin of 2.5 percentage points. In addition, as we noted in the Q4 call, our labor costs are up about 3.3 million due to an additional 70 employees in the current quarter, most of whom were hired in 2022, along with annual merit increases that took place on January 1 of this year. This increase represents approximately 25% of the 12 million rise we noted in our Q4 call. This had an impact on our EBITDA margin of 3.6 percentage points. As our revenue grows sequentially throughout the year, and the audit costs do not recur, we will see an expansion of our EBITDA margin. As we stated last quarter, we are careful with our incremental hiring and are looking for ways to lower our non-employee costs. The sales and marketing realignment has taken place, and we are starting to see some of the benefits of the new structure. I am pleased to report that the VA has begun the rollout of the EC fax service. Two facilities were deployed post the close of the quarter, and there is now a roadmap for the next several months. We will generate a minimal amount of revenue in Q2 and see the rollout ramping in future quarters as more facilities are brought online. There are now more than 20 agencies interested in the service. Ten prospects have already been provided a demo and are in active discussions with Cognosante and ourselves. It is still early, and we do not expect any of these new agency opportunities to produce revenue in 2023, but are encouraged by the widespread interest in the solution. Before handing the call over to John, I'd like to discuss our liquidity and capital allocation alternatives. We remain very liquid with more than 111 million in cash on our balance sheet and a $50 million undrawn line of credit that we put in place back in March of 2022. These funds are targeted to get paid down, which cannot occur until the second anniversary of the spin in October of this year, and for opportunistic stock repurchases. To that end, in the quarter, we were able to repurchase approximately 270,000 shares at an average cost of approximately $34 per share. I'll now turn the call over to John.

Thank you, Scott. As you'll recall, in our last update, we announced a broad realignment of our go-to-market organization. This action was taken to build upon our sales and marketing foundation that we had established post-spin, focusing on improving both efficiency and effectiveness in our revenue-generating efforts. As part of that initiative, we eliminated the revenue stream designations of enterprise, mid-market, and SOHO, streamlining the organization into strategic sales and direct sales. As reassurance to the interested call audience, we will continue to report SOHO results consistent with your current models. However, operationally, we manage under the realigned structure. This past quarter, following an extensive search, we were able to secure new leadership for our direct sales team and are closing in on our targeted staffing level. The activities around implementation and normalizing operations under the new structure are progressing. In addition to the organizational changes, we have completed an extensive account reassignment project and initiated outreach to customers for introductions to their new Consensus content. In concert with this, there have been several changes to the quota assignment and commission system designed to better motivate the sales team and drive top-line performance. These improvements to quota and commission are the results of a data-driven approach employed by our sales enablement team, and we will continue to further our data analysis program to identify opportunities for the business. One more facet of the sales piece of the realignment is the establishment of a new account development team. This group is using new analytics tools to target existing accounts for wallet expansion activities. While still fully developing their approach, this team has already contributed nicely to our pipeline building results for Q1. On the marketing front, we have merged the former corporate and web teams into a single marketing organization. The team has begun evaluating the business more holistically and identified several tools that will increase the efficiency and effectiveness of our marketing efforts. The team has also worked hard on ensuring our success at two major healthcare conferences held recently in Chicago and Nashville, resulting in the acquisition of hundreds of new leads and the ability to demonstrate clarity to thousands of new healthcare leaders. Surrounding the entire go-to-market restructuring is our IT infrastructure, and the work to arrange all reporting, forecasting, billing, and attribution changes in support of the new organization is an ongoing task. Given the size and scope of the work needed to complete this project, we expect that it will be an ongoing effort for the entire balance of 2023. In the next slide, we can walk through some of the key operating results for the quarter. Consistent with our commentary on the Q4 call, we continue to see delayed decision-making in the face of client-side staffing shortages and customer project backlogs caused largely by current macroeconomic uncertainty. I would describe the sales outcome as flat, slightly up sequentially from Q4, and down slightly year-over-year. While we have worked hard to mitigate the impact of our realignment on overall sales productivity, as you can tell from the earlier slide, there was a lot of activity around this, and there was certainly some loss of sales efficiency in Q1. That said, there were a few items of note that are important to discuss. First, sales of fax were up both over Q1 of 2022 and sequentially over Q4. Additionally, the advanced interoperability pricing accounts for a significant portion of overall sales, coming in at 30% of bookings. Another notable point is that the upsell program we announced last year, designed to accelerate through the realignment, accounted for nearly a million dollars of new bookings, expanding our revenue from existing accounts. Finally, we closed two larger deals as the feature set is proving very competitive against market incumbents. We remain pleased overall with the state of our pipeline, and while we continue to see slow prospect movement through the sales process, it remains strong and continues to grow with both government agencies and our commercial prospects. In the SOHO business, there are only a few months of annual plans to adjust to the price increase we enacted last June. The customer base overall is holding solidly within our model expectations for churn, with churn for the quarter improving by six basis points from Q4. This past April, we had our first two successful deployments of the EC fax solution for the VA with additional sites planned in the coming months. It's still early times here, and we haven't yet gotten to a predictable cadence for us to confidently forecast the pace. We look forward to working towards some normalization on that front, but until that time, it will remain somewhat lumpy and difficult to accurately anticipate the EC fax contribution in the coming months. The first production instance of clarity has been accepted by the customer, and the roll-out timing is dependent on availability of client-side resources. We also had very successful demonstrations of the clarity technology at recent conferences. Interest in AI-powered solutions is reaching a high level. Meanwhile, we have active proofs of concept with additional customers and are engaged in multiple discussions with pipeline prospects. The product team is working on several fronts, including security, new products, and infrastructure improvements. Our high trust annual certification is underway, and we will introduce J-sign as a new addition to our high trust certified product set. Progress continues on harmony. We are at code completion with a production version of fax-to-direct, a feature that allows faxed documents to be delivered as secure messages across the Direct Trust network, enabling providers to use either a recipient fax number or their direct address to securely deliver vital healthcare information. As announced in the last call, our product team is introducing a new discipline of product marketing, creating a more effective bridge between the engineering work that produces products and the commercialization process. We have successfully recruited a strong leader for the team and are beginning the work of establishing this vital function for the business. As we discussed on the last slide, there is an important systems component to our realignment that the product engineering team is building as part of our larger genesis initiative, which includes salesforce integration and consolidation of our billing systems to generate more insightful reporting for the sales enablement team to use as a key component of their data-driven approach. Finally, the engineering team is working on several system improvements that will support our upmarket move in Japan. Several large prospects in Japan have expressed interest in a corporate version of our product, which has historically not been available in the Japanese market. We anticipate beginning these upmarket activities in Q3. In summary, we have made significant progress on our realignment initiative, and while there remains more work to do, we're pleased with what has been accomplished. We continue to see slow decision-making in our prospect pipeline; however, the dialogue remains active. Sales results for the quarter meet our expectations given the macroeconomic environment, and progress in our upsell efforts, along with J-sign gaining traction, are encouraging. The VA rollout has begun, our first clarity production installation will commence once client-side resources become available, and the SOHO base churn has held within expectations. Lastly, the product development team remains focused on security, harmony development, and infrastructure support of the go-to-market realignment. Now let me turn the discussion over to Jim Malone, our CFO.

Thank you, John, and good afternoon, everyone. Let's start with our corporate business results. Q1, 2023 corporate revenue was $49.4 million, an increase of 2.9 million or 6.2% over the prior year comparable period. On a constant dollar basis, corporate revenue increased by 6.4%. The difference is due to a greater portion of paid debts coming from SMB customers and the acceleration of SOHO migration to corporate. Monthly churn was 1.4%, down from 2% for the prior year, supporting our last 12 months revenue retention of approximately 102%, consistent with our expectations. Moving to SOHO results, Q1 revenue aligned with expectations at $42 million, a decrease of approximately 0.8 million or a negative 1.8% compared to the prior year comparable period. On a constant dollar basis, SOHO revenue decreased by 0.4 million or 0.7% negative. The average revenue per user (ARPU) increased by $1.22 or 9% year-over-year. Monthly churn was 3.8%, up from 3.5% over the prior period and within expectations. The year-over-year revenue decrease was due to lower paid debts, partially offset by higher revenue related to price increases, which enhanced the contribution to SOHO fixed revenue. Moving now to consolidated results for Q1, revenue was 91.5 million, an increase of 2.2 million or 2.4% over Q1, 2022. On a constant dollar basis, revenue increased by 2.7 million or 3% year-over-year. Reported adjusted EBITDA was 44.2 million, a decrease of 4.4 million or 9%, delivering a 48.4% adjusted EBITDA margin, driven by planned employee-related expenses and professional fees in connection with the 2022 year-end audit. Non-GAAP EPS of $1.10 was lower by $0.23 or 17.3% compared to the prior year period, driven by the adjusted EBITDA items mentioned and a negative $1 million non-cash foreign exchange impact related to the intercompany balance revaluation, partially offset by higher revenues. We ended the quarter with 111 million in cash, which is more than sufficient to fund our operations and debt. We are reaffirming full-year guidance for revenue, adjusted EBITDA, and adjusted non-GAAP EPS. The 2023 guidance ranges are as follows: revenue from 370 million to 390 million, with 380 million at the midpoint; adjusted non-GAAP EBITDA from 192 million to 206 million, with 199 million at the midpoint; and adjusted non-GAAP EPS from $4.93 to $5.20, with $5.08 at the midpoint. Our Q1 non-GAAP tax rate and share count was 19.98% and 19.9 million shares within our 2023 guidance. We are planning to file our Q1, 2023 10-Q at market close tomorrow, May 10. This concludes my formal remarks. I will now turn the call back to the operator for the Q&A session. Thank you.

Thank you. We will now be conducting a question and answer session. And the first question from the line is coming from Ian Zaffino from Oppenheimer. Ian, your line is live.

Hi. Thank you very much. I joined a couple of minutes late but glad to see this VA is now being implemented. How do we think about the ramp of the VA as it relates to the remainder of the year and then into 2024? Thanks.

Yes, Ian. This is Scott. Appreciate the question. So the way the VA rollout works is there's an initial group of five facilities of which two have launched, as was noted in our press release and comments. The other three are to be launched over the next 60 to 90 days. Cognosante, the VA, and ourselves are working down on a plan for the rollout beyond that timeframe. There are different methods of doing it. What has occurred today is to go facility-by-facility, with the goal of cutting over predominantly, if not exclusively, all of the modes by which that facility sends and receives faxes. This includes porting of telephone numbers for inbound faxes that may be connected to servers, multifunction printers, and devices. The outbound piece involves sending documents via the service, which does not require a telephone number to effectuate that. The first five are going on a full cutover basis. Typically, with our corporate clients, if they are as sophisticated as the VA facilities are, we do it in phases. Instead of trying to do everything all at once, we find that there’s often a distribution of traffic, so we would phase that to be cut over at the end. Currently, this is not the approach we're using. Cognosante, the VA, and ourselves are working with a plan to have a more streamlined approach once we get through the first five, hoping to expedite rollout, particularly for the outbound services. For the first five facilities, I think they will have a minimal contribution to revenue in Q2, slightly above minimal in Q3, and hopefully greater than that in Q4. It’s as we get beyond the first five and start layering in the ramp beyond that that we can give a clearer outlook for 2024, but I don’t expect the current VA contract to be a major contributor in 2023.

Okay, thank you. And then on the margin side, how are you thinking about margins as we kind of enter a recession or the slowdown we're seeing? Margins were down year-over-year. How do you intend to hit that margin target, and what type of offsets can you do on the cost front? Thanks.

Well, we focus first on the EBITDA margin, that's the 50 to 55 range. If you look at Q1, we had these unfortunate large expenses related to the 10-Q filing and the delayed 10-K filing of about $2.3 million compared to what we spent in Q1 of 2022. That's 2.5 points in margin right there, and those expenses certainly will not recur. Our audit and other professional services decrease dramatically in Q2 and Q3, and we start to ramp up in Q4 as we look towards the next audit cycle. Having said that, there is about $12 million of increase year-over-year in compensation expense related primarily to our employees. We have about 70 more employees in Q1 of '23 versus Q1 of '22, although it's essentially flat with where we were at year-end. However, we do have merit raises that took effect in January of this year, so that's been fully budgeted, and we felt the full quarter's effect of that with an increase of non-GAAP compensation expense of about 3.3 million. I expect that will persist throughout the year. As our revenue grows, we should see the margin continue to expand off of what I'll call the pro forma margin of about 50% to 51%, when I account for the excess accounting and legal fees. We're very judicious on incremental costs, especially in light of a potential recession. We're still hiring but not at the pace we did in 2022. Beyond employee costs, which make up about 56% of our total cash cost structure, we are looking for areas to cut expenses or trim costs. Therefore, we will likely see some incremental savings in non-compilation-related expenses as we progress through the year.

Okay, thank you very much.

You are welcome.

Thank you. The next question is coming from Jon Tanwanteng from CJS Securities. Jon, your line is live.

Hi, good afternoon. You answered a lot of the questions in the prepared remarks, do appreciate that. Going back to you, you talked about delayed decision-making impacting sales. Can you break that down in terms of how it's affecting healthcare budgets? Specifically, are there any reasons why IT departments are getting stuck? Also, how does this relate to non-healthcare corporate end markets such as legal and financial? Are they seeing similar headwinds to healthcare?

Yes. Thank you for the question. I appreciate that. I think what you've got in healthcare is a lot of pressure on healthcare IT organizations to stay staffed. We started to see that as we came out of the pandemic, but it's accelerated since about mid-last year. Healthcare has been hard hit with the ability to find some of these technical resources needed to run their IT projects. If you're a large health system, you have multiple IT projects in progress, and a dwindling number of staff to help implement them. While our implementation is a relatively minor task, it still requires coordination with client teams. We’re seeing a considerable impact in our ability to generate revenue in those areas. There is also some cautiousness; decision-makers are careful about pulling the trigger on purchases. We’re still having productive conversations, but the questions around timing are significant. Many are trying to determine when the recession may hit and its effects, which complicates the decisions regarding new technology investments.

Very helpful. Thanks. I'll jump back in the queue.

Before Paul, we go to the next question, we received a few that have come by email. These are quick answers. One question is whether the VA contract or Japanese expansion revenues mentioned by John are included in our guidance. The answer is no. Our guidance is quite wide, and the range's upside could be partly driven by contributions from these new contracts, but I don’t expect them to significantly affect our performance this year. Another question regarding costs is about our expenses. Excluding the audit costs which I referred to earlier, our SG&A and R&D costs came in pretty much in line with expectations, with only minor variances. Let's go back to live questions.

Certainly. The next question is from email, but I’ll now turn to John for additional color on our relationship with AWS, the ISV opportunity.

Absolutely. Our growth over the last two or three years has been part of our development in the channel area. The channel program started around 2017 or 2018. Regarding AWS as a channel, large customers often use AWS as their technology solutions platform. AWS becomes a good source for them to direct quality vendors like us and enables compatibility with their existing environments. As we engage with AWS and customers introduced through them, the ecosystem ensures that we have solutions that can work seamlessly together, which is pivotal for driving top-line growth.

There are no other questions from the dialed audience. Now, I'd like to hand the call back to Scott Turicchi for closing remarks.

Great. Thank you, Paul. Thank you all for participating today in our Q1 earnings call. We will release information about upcoming conferences soon. We’ll participate in a Goldman Sachs conference and a Needham conference held virtually. The next regularly scheduled call will be to report Q2 earnings, likely the week of August 8 or 9. Thank you.

Thank you. This does conclude today's call. You may disconnect your lines at this time. Have a wonderful day, and thank you for your participation.