Consensus Cloud Solutions, Inc. Q4 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to Consensus Q4 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; Jim Malone, CFO; Johnny Hecker, CRO and Executive Vice President of Operations; 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 Q4 and fiscal year-end 2023 financial results, other key information, and 2024 guidance. Joining me today are Scott Turicchi, CEO; Johnny Hecker, CRO and EVP of Operations; and Jim Malone, CFO. The earnings call will begin with Scott providing opening remarks. Johnny will give an update on our operational progress since our Q3 investor call, and then Jim will discuss our Q4 2023 and year-end preliminary unaudited financial results and 2024 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 slideshow 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. As we discussed in our Q3 call, our focus has been on EBITDA and free cash flow generation. The market dynamics have not materially changed since our last call in November, and we expect these trends to continue throughout 2024 in the healthcare sector. We've taken the past three months to conduct a rigorous examination of the business to see where costs can be optimized. As we noted in the Q3 call, we found certain expenditures in our SoHo channel that resulted in low LTV customers. As we look even deeper campaign by campaign, we identified additional spending that was at best marginally profitable and most likely uneconomic. As a result, we've made further cuts against our Q4 forecast which had a slight negative impact on revenues in the quarter but favorably affected EBITDA productivity and margin. On the corporate side, revenues were impacted by the enhanced collections process that reduced our outstanding receivables but also resulted in some account closures, affecting the base coming into 2024 and likely impacting corporate revenue growth rate by approximately 1 percentage point. Johnny will provide you with further details in his part of the call. I am pleased to report that for the quarter, we generated near our target EBITDA, notwithstanding the headwinds on the top line. Our bottom line EPS, while strong, was negatively impacted by a significant rallying of the euro against the US dollar that resulted in a charge of $5.8 million or $2.4 million more than our forecast. I would note that these are inherently difficult to predict and are noncash in nature. We are actively working on a program to mitigate this volatility in 2024. The strong bottom line results, combined with the finance team's collection efforts, allowed us to achieve $10 million better in free cash flow compared to Q4 of 2022. For the full fiscal year, we produced $77.7 million of free cash flow compared to $53.1 million in 2022. This allowed us to repurchase $71.4 million of our bonds through January at an average price across both tranches of 91% of PAR. We ended the year with a healthy $88.7 million in cash and cash equivalents. Looking to 2024, the biggest change from our preview in November is how we are managing the SoHo channel. Due to changes in algorithms, rising advertising costs, and an increasing amount of new sign-ups with limited use cases, we are cutting almost two-thirds of our marketing spend in 2024 relative to 2023. Consequently, we will see a faster decline in revenue for SoHo in 2024 than previously articulated. However, costs are declining by approximately the same amount as revenues. We continue to invest in our corporate channel, allocating a few million dollars of additional marketing spend to support these efforts. We are also seeing initial benefits from the go-to-market realignment that we implemented around a year ago. We remain optimistic about the opportunities within the healthcare sector for our core fax products and interoperability solutions. We expect an increased corporate contribution exiting 2024 as a result of this strategy, and we will continue to pursue it while generating cash and reducing our debt. At the midpoint of our guidance range, we expect EBITDA to grow in 2024 with margins expanding by approximately 290 basis points. We are also reducing our capital expenditures by about $7 million from the 2023 level while continuing to invest significantly above pre-spin levels. Despite an anticipated higher tax rate than in 2023, we still expect to generate around $80 million in free cash flow. I will now turn the call over to Johnny.

Thank you, Scott, and hello, everyone. Let me provide an update on our sales and operations, starting with our corporate business. In the fourth quarter of 2023, our corporate revenue reached $49.4 million, reflecting a steady increase compared to the previous year's $47.8 million. We are excited to report the ongoing success of our SoHo upsell strategy with approximately 1,250 accounts added in Q4 and a total of around 4,700 accounts shifted from SoHo throughout the year. Advanced products accounted for 13% of our total new sales, continuing our strategic focus and contributing to a 23% share for the full year. Additionally, our eFax protect offering has yielded impressive results, adding approximately 1,000 paid customers in the quarter thanks to the Q3 introduction of a new e-commerce channel tailored specifically for corporate clients. Moving on to SoHo, as anticipated and regularly communicated, we saw a decrease in revenue during Q4 of 2023, at $38.3 million compared to the previous year's $42.2 million. As discussed in Q3, we cut some unproductive advertising spend, and as we analyzed further, we made additional advertising cuts in Q4, which will continue into our 2024 budget. Our goal is to optimize our SEM spending, focusing on targeting the most profitable customers. As a result of this decreased intake, our total account base decreased from 859,000 to 831,000. However, it's important to note that our churn rate improved from 3.49% in the previous quarter to 3.34%, in line with our expectations given our more selective customer acquisition strategy. Now for some key updates shaping our operations. Firstly, the rollout for the VA has begun to accelerate. All parties involved have worked closely to adopt a new rollout method, ensuring a smooth and efficient implementation. Consequently, we expect to reach a seven-digit contribution in 2024 with promising runway beyond that. With regards to our ECFax offering for the federal government and other agencies, progress has been steady, albeit slow. The pipeline remains robust, but prospects remain cautious regarding the ongoing federal government spending cap issues. We're monitoring developments closely as we await the federal budget resolution. It's worth noting that our commercial offering eFax corporate has proven to be a viable alternative for smaller governmental agencies with less demanding requirements. I'm pleased to share notable successes, including partnerships with MRO, a customer in the healthcare IT space, and Lexmark, a leading provider of printing and imaging products, software solutions, and services. Our go-to-market realignment strategy has yielded positive outcomes, particularly with the earlier noted success of eFax protect, our corporate e-commerce offering. We have strategically redirected our focus toward our existing customer base, maintaining the healthcare industry as our gold standard for new business and product strategy. We're actively cultivating partnerships with electronic health record and healthcare IT vendors. I'm happy to report that our go-to-market realignment efforts have resulted in increased operational efficiency, steady booking results, a stable sales pipeline, and data-driven adjustments to our strategies. Let's briefly discuss our product updates, beginning with our AI-driven solution, Clarity. We continue to build a solid pipeline for Clarity CD for clinical documentation and Clarity PA for prior authorizations. We are excited to announce that we have already booked our first Clarity CD customers. New prospects and existing customers have shown great interest in adopting AI as a real-world solution, allowing them immediate savings. Additionally, our first-generation Harmony offering is now in production, marking a significant milestone in our product roadmap. This specific application of Harmony enables the center to transmit a fax document, which Harmony then delivers as a direct secure message, a widely used electronic delivery protocol in healthcare. We are partnering closely with one of the leading cloud-based EHR and practice management solution providers for small and medium-sized medical practices on this project. Looking ahead to 2024, it's key to recognize that while we see positive changes within our organization, we are adopting a conservative outlook on our growth prospects. By optimizing our marketing efforts to focus on increased profitability, we've emphasized margin and retention. While top-line growth will be moderate in the near term, our primary focus remains on cash generation and achieving operating profits. In our SoHo business, we've implemented strategic measures as part of our go-to-market realignment. By merging the marketing departments for SoHo and corporate, we aim to leverage deeper insights from a propensity analysis showing that a portion of our SoHo base possesses corporate attributes. We're pleased to have finalized eFax price increases in early 2023, allowing us to concentrate on a more engaged user base. During 2023, we encountered challenges related to significant changes from our major digital advertising partners, aimed at stabilizing their businesses but increasing our customer acquisition costs and yielding less profitable customers. To navigate these challenges, we've performed a thorough analysis of our campaigns to identify those yielding high-quality customers. In our last earnings call, we reported that we narrowed spending on campaigns targeting high-profit customers starting in Q3 2023 and are continuously evaluating campaign effectiveness. Our focus on the Smarter Aspen project involves analyzing our subscriber base to optimize digital advertising spending. We're closely monitoring ad costs and will strategically re-enter campaigns when the LTV to CAC ratio meets our defined return levels. The reduced spending in SoHo allows us to redirect a portion of net advertising spend to corporate while lowering SoHo spend. Our strategy prioritizes high LTV customers, positively impacting the profitability of newly acquired SoHo customers. Encouragingly, we are observing early signs of success, with a decreased CAC resulting from increases in organic sign-ups and reduced overall spending. Overall, we plan for approximately $139 million in SoHo revenue at the midpoint for 2024. Through active management, we expect this targeted reduction in revenue to allow us to maintain and potentially improve cash generation compared to previous periods. Now let me address the corporate business and direct you first to our balance sheet. You will notice a significant decrease in our accounts receivables from Q3 to Q4 of 2023. We've expanded our collections team rapidly, focusing on rigorous collections management in those quarters. Jim will elaborate on this in his prepared remarks. While our efforts improved cash generation, they also resulted in increased customer terminations affecting both our 2023 revenues and run rate entering the new year. Regarding other impacts on our baseline, the FaxBox migration in Europe led to discontinuation of that platform, retaining less than half of its base. While this may seem significant from a top-line perspective, it is justified from a technical platform retirement and cost standpoint. Furthermore, the acquisition of Summit, conducted for its talent and technology, continues to generate baseline revenues, but it declined in 2023 and will not contribute to growth in 2024. As we previously mentioned, slow decision-making during 2022 and throughout 2023 did not generate the addition of new business as initially anticipated in our post-pandemic plan for 2023. Consequently, we have adopted a more conservative approach to our baseline. We see little change in that behavior, keeping our new revenue ambitions roughly flat. Despite the challenges, we are budgeting corporate revenue to $206 million at the midpoint for 2024, representing a 3.1% growth compared to 2023, aligning with our recent quarterly growth rates. Looking forward, we're maintaining stability in new business while anticipating initial returns from the Japanese corporate launch. In response to market conditions, we initiated focused sales initiatives in 2024 and reallocated resources to enhance customer retention and cross- and upselling opportunities within our large baseline. These initiatives position us for accelerated corporate growth in 2025 while remaining committed to cash generation. With that, I'll turn the call over to our CFO, Jim Malone, who will provide further details on our Q4 2023 and full-year 2023 financial results as well as our 2024 guidance.

Thank you, Johnny, and good afternoon, everyone. In our press release and on this earnings call today, we are discussing preliminary unaudited 2023 results and 2024 guidance. Our fiscal 2023 audit is still underway, and will result in audited financial results filed with our 2023 10-K, scheduled to be submitted late next week. Let's start with our corporate business results. Q4 2023 revenue was $49.4 million, an increase of $1.6 million or 3.3% over the prior comparable period. Q4 2023 year-over-year corporate revenue growth increased by 30 basis points versus Q3 2023 year-over-year. As Johnny mentioned, Q4 year-over-year revenue was negatively impacted by the cleanup related to Q4 collection efforts, migration of FaxBox to legacy platform, and Summit. In the second half of the year, we placed increased focus on cash collections, improving collections by 9% from slow-paying customers, though it did lead to terminations of non-paying customers. Corporate ARPA of approximately $306 was down $16 or 4.9% from the prior year, driven by the mix of paid ads at lower ARPA, including SoHo accounts moving to corporate and the new eFax Protect initiative that Johnny mentioned. Monthly churn of 1.82% increased by 33 basis points, delivering a trailing 12-month revenue retention of 99%. The churn increase was primarily due to the terminations of non-paying customers. Corporate revenue for the full year 2023 was $199.6 million, a $7.4 million or 3.9% increase over 2022 results. Year-over-year revenue was also affected by the cleanup initiative related to Q4 collection efforts, migration in FaxBox, and Summit. Moving to SoHo results, Q4 2023 revenue was $38.3 million, a decrease of $4.1 million or 9.6% over the prior comparable period. This decrease was anticipated, given the impact of price increases from the prior year and lower optimized advertising spend. This approach resulted in a net base reduction due to fewer paid ads but potentially higher value customers, partially offset by an increase in ARPA. ARPA of 15.12% increased by $0.41 year-over-year, benefiting from last year's price increase. Churn declined 48 basis points to 3.34% compared to the prior period, now at pre-pandemic churn levels. Full-year 2023 SoHo revenue reached $162.9 million, representing a $7.3 million or 4.3% decline from 2022 results, which is in line with our full-year SoHo guidance range of negative 4% to negative 2%. Moving to Q4 consolidated results, revenue of $87.8 million is an increase of $2.5 million or 2.7% over Q4 2022. Adjusted EBITDA of $47.2 million and a 53.8% margin was a decrease of $1.8 million or 3.7% over Q4 2022. The primary drivers of this revenue decline relate to anticipated employee-related expenses, partially offset by effective cost management. The EBITDA margin of 53.8% is within our guidance range of 50% to 55%. Adjusted non-GAAP net income of $21.3 million decreased by $1.3 million or 5.6%, driven by lower revenues and a higher tax rate, offset by interest income of $1.5 million and noncash foreign exchange revaluation of intercompany accounts of $0.5 million. Adjusted non-GAAP EPS of $1.11 was lower than the prior comparable period by 1.8% or $0.02. For Q4 2023, non-GAAP tax rate and share count were 21.8% and 19.2 million shares, respectively. Moving to 2023 full-year consolidated results, consolidated revenue of $362.6 million is essentially flat compared to the previous year. Adjusted EBITDA of $186.6 million decreased by approximately $10 million or 5.1% compared to the prior comparable period, delivering a 51.5% margin within our 50% to 55% guidance expectations. The main year-over-year EBITDA driver and flat revenue is related to employee-related expenses. Adjusted non-GAAP net income of $99.8 million decreased by $6.8 million or 6.4%, driven by lower operating income, partially offset by interest income, expense benefit of $4.2 million, and lower tax expense by $2.7 million. Adjusted non-GAAP EPS of $5.09 was lower than the prior comparable period by 4.5% or $0.24. The 2023 non-GAAP tax rate and share count were 19.7% and 19.6 million shares, respectively. As mentioned during our Q3 2023 earnings call, we announced a $300 million bond repurchase program approved by the Board of Directors. In Q4 2023, and the first week of January 2024, we repurchased $62.6 million and $8.7 million in both tranches for $57.1 million and $7.9 million cash, respectively. We repurchased 349,000 and 1 million shares in Q4 and throughout 2023, respectively, with a cash outlay of $8.5 million and $23.5 million. We ended 2023 with $88.7 million in cash and cash equivalents, sufficient to fund our operations and continue to repurchase debt and equity. Our normalized cash balance as of December 31, 2023, would have been flat compared to September 30, 2023, at $156 million, excluding the $65.5 million in bond and equity repurchases. The free cash flow for 2023 was $77.7 million. For additional assistance with our quarterly guidance, we will be releasing additional guidance for the current quarter soon. For the year 2024, guidance is as follows: revenues between $338 million and $353 million with $345 million at the midpoint; adjusted non-GAAP EBITDA between $182 million and $194 million with $188 million at midpoint; and adjusted non-GAAP EPS at $5.08 to $5.31 with $5.20 at midpoint. For Q1 2024, revenues are expected to be between $85 million and $89 million with $87 million at midpoint; adjusted non-GAAP EBITDA between $45 million and $48 million and $46 million at midpoint; adjusted non-GAAP EPS at $1.27 to $1.33 with $1.30 at midpoint. Estimated share count and income tax rate are 19.4 million shares and 20.5% to 22.5% respectively. This concludes my formal remarks. Now I'd like to turn the call back to the operator for Q&A.

The first question today is coming from Jon Tanwanteng from CJS Securities. Jon, your line is live.

Hi, good afternoon. Thank you for taking my questions. I guess my first one for Scott or Johnny, when do you think the decision-making labor issues impacting your corporate business will begin to resolve or inflect? Is there any light at the end of the tunnel, or should we expect this to continue for the foreseeable future?

Jon, this is Johnny. Yeah, thanks for that question. I wish we had a better answer. What we're experiencing is a bit more decisiveness, but it's not at a trend that we're seeing as an immediate end. So for our 2024 budget, we have anticipated not seeing much improvement throughout the year.

Okay, got it. At 3% growth in change with the VA contributing, is that corporate growth not happening without the VA? Are there other components to that?

No, corporate will grow without the VA for sure. VA is not a major contributor but is part of the 3%.

Got it. Okay. Do you still see fax volumes growing across the same customers year-on-year?

Absolutely. We see customers, particularly larger customers, showing tremendous growth in individual usage. This growth is driven by factors such as M&A within large companies, as they acquire additional volumes, and many customers are still migrating from on-prem solutions to the cloud.

Understood. Thank you. I was wondering when you expect the impact of the lower spend in the SoHo business to level off from a sequential decline perspective? Will that take most of the year? What does this look like?

The level of the spend or the revenue component associated with it? I'm not sure I understand.

The revenue and user component associated with the decline in spend.

That will continue throughout the year and could even extend into next year. We'll monitor exactly where that sweet spot is concerning the budget number, which could be a couple of million dollars higher or lower. As we review various campaigns and their lifetime value expectations, it will inform our spending decisions, providing clarity as we approach 2025. However, you should expect a decline in the base from the predecessor quarter for all four quarters of 2024.

Got it. Is there a point where, with enough high-quality customers, the SoHo business can eventually stabilize or grow, or do you expect it to continue declining?

I believe that once we swap out customers who have signed up within the last 12 to 15 months and have shorter lifespans, while it's true that revenue will be lower than in 2023, we can stabilize that number moving forward. I don't expect the SoHo channel to grow, but I do think we can achieve stability in that segment.

Got it. Thank you. I’ll jump back in the queue.

Okay.

Hi. Can you talk a little bit about Clarity, jSign, HITRUST, and Harmony? Please comment on pricing revenue contribution and broadly speaking, how these products benefit your hospital clients in the long term?

Sure. Let me start with Clarity. Clarity is our AI and NLP-based solution that helps extract data from unstructured documents and images like fax, including hard-to-read handwritten data, transforming it into structured data for easier processing within other systems such as electronic health records. It's a technology platform that we are building out to provide individual applications for specific use cases. The Clarity CD platform for Clinical Documentation helps extract demographic data from incoming documents, enabling quicker processing than traditional manual methods. Our solution for prior authorizations does similar tasks, accelerating turnaround times in compliance with the new CMS rules for timely authorizations, benefiting both providers and payers. The jSign application is designed for electronic signatures in healthcare, similar to DocuSign, ensuring that documents processed by fax that require signatures can efficiently return to our clients. Harmony is where we see multiple technologies converge, allowing customers to choose preferred technologies and transportation protocols. The initial product we've launched allows fax documents to be securely transmitted as messages, improving efficiency. We are also working with a leading cloud-based EHR and practice management provider for small to medium-sized medical practices. From a revenue perspective, the bulk of our revenue still comes from fax, and we foresee future adoption of these technologies. Pricing varies per technology; however, we continue with subscription and usage-based pricing models for these technologies.

I want to add that HITRUST certification has been achieved for our core eFax service and jSign, although Clarity is still in the queue, and Harmony is at its early stages. Collectively, these products currently contribute low single millions of dollars in revenue, which we expect to grow as adoption increases.

That's great. What is the revenue contribution from these products, and what is the current penetration rate? What kind of lift can we expect from these products?

Most of our revenue still originates from the fax platform, but we will expand and find acceptance in these new technologies. Pricing depends on the technology, analogous to the fax payment structure, usually on a per-document or per-page basis. We're maintaining subscription and usage-based models across all technologies.

You also inquired about our relationships with EMRs such as Epic, Cerner, and MediTech. Some EHR vendors choose us as their default cloud fax platform; however, we integrate with all of them. Our API technology successfully connects any EMR to our cloud platform, and we have customers across all technologies mentioned.

You mentioned a win with 65 hospitals and 107 skilled nursing facilities and 25 urgent care centers. Was this the VA or a different hospital system? What is their revenue contribution, and when would that begin to roll into the books?

That was not the VA. It was another nonprofit. For a customer of that size, you can anticipate a seven-digit contribution. We're currently in the rollout phase, which is dependent on their IT teams and partners. We expect this rollout to be much faster than the VA's, given they have over 2,200 facilities.

Hi, thanks for taking my question. Can you discuss your conversations with hospital customers around demand? Are the conversations leaning towards deferrals or longer-term investments?

We're seeing positive signs; hospitals acknowledge it's time to pursue these projects. Some are still under economic pressure, while others see improvements in cash flow. However, the labor market, particularly for IT talent, remains tight. Hence, we can help alleviate pressure on nursing and administrative staff, but securing a priority slot is key, and while we see traction, it isn’t as fast as we’d like.

What are your thoughts regarding margin improvement despite revenue shortfalls? Which areas present the most opportunities for lean operations?

Most margin improvements are occurring in advertising and marketing. The strategy for the SoHo channel is a permanent shift in how that revenue stream is managed, reallocating some marketing dollars from SoHo to corporate. Although there are minor savings in our telco costs, the bulk of savings is certainly in marketing. If we look to 2025, the delta in marketing costs will lessen as we fine-tune other areas.

As you provide guidance for next year, what level of churn are you embedding within that?

For the SoHo segment, we expect elevated churn due to reduced spending and sign-ups, which historically shows we lose about two-thirds of customers in their first year. Therefore, as this cohort ages, we expect that churn rate will decrease. Although I won't specify the exact numbers, we will aim to see it move below 3%.

Churn should decline between 40 and 80 basis points throughout the remainder of the year.

On the corporate side, cancellations resulting from aggressive AR collection increased the cancel rate from Q3 to Q4, but we believe it's stable in the range of 1.25% to 1.5% for 2024.

Can you clarify the timing of the VA contribution? Are we looking at contributions in Q1, or is it more second-half focused?

There's a minor contribution starting in Q4. However, we expect to see steady ramp-up in each subsequent quarter throughout 2024 and likely into 2025. Ongoing work since our pilot phase is yielding more traffic every month, which we expect to build.

When do we reach run rate levels? Are we looking at '25 or '26?

The VA has set specific goals and objectives, leading to more efficient traffic growth compared to 2023. We anticipate not achieving a full ramp until 2025 or potentially 2026.

Regarding free cash flow generation for 2024, why shouldn't we expect even higher figures given lower CapEx and improved collections?

We do expect free cash flow to improve, but our tax rate is increasing this year compared to 2023; these will be cash taxes. So even with rising EBITDA, higher taxes will impact total free cash flow. The expectation is around $81 million to $82 million based on these factors. We will prioritize cash flow allocation towards repurchasing bonds and equity, considering potential acquisitions on a limited basis due to challenging valuations.

No further questions.

Is there a stable portion within the SoHo customer base, and is attrition concentrated in specific segments?

There is a stable core base, and as we reduce marketing expenditures, we'll better stabilize revenues over time. Although I can't give a precise cutoff, we will find a clearer picture in two to three years.

Is ARPU expected to remain similar as you're adding new customers?

The average revenue per account continues to fluctuate. We are converting lower-value SoHo customers into corporate, ultimately impacting ARPU, but it will differ based on the customer mix. Thanks for joining us today in this recap of our Q4 results and our outlook for 2024. We will announce future conference schedules regarding our reporting on the first fiscal quarter, expected around early May. If you have any questions before then, feel free to reach out. Thank you and we'll talk soon.

Thank you. This concludes today's conference. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.