Clarivate PLC Q1 FY2020 Earnings Call

Good morning and welcome to Clarivate’s First Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Mark Donohue, Vice President of Investor Relations. Please go ahead.

Thank you, Andrew and good morning everyone. Thank you for joining us for the Clarivate first quarter 2020 earnings conference call. With me today are Jerre Stead, Executive Chairman and Chief Executive Officer; Richard Hanks, Chief Financial Officer; Mukhtar Ahmed, President of Science Group; and Jeff Roy, President of the IT Group. All will be available to take your questions at the conclusion of the prepared remarks. As a reminder, this conference call is being recorded and webcast. This morning, Clarivate issued a press release announcing our financial results for the period ended March 31, 2020. The release as well as an accompanying supplemental presentation is available on the Investor Relations section of the company’s website, clarivate.com under Events and Presentations. During our call, we may make certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from anticipated results. Information about the factors that could cause actual results to differ materially can be found in Clarivate’s filings with the SEC and on the company’s website. Our discussion will include non-GAAP measures including adjusted revenue and adjusted EBITDA. Clarivate believes non-GAAP results are useful in order to enhance an understanding of our ongoing operating performance and should not be considered in isolation from GAAP financial measures. Reconciliations of these measures to GAAP measures are available in our earnings release and supplemental presentation on our website. After our prepared remarks, we’ll open the call up to your questions. And with that, it’s my pleasure to turn the call over to Jerre.

Thank you, Mark and thanks to all of you for joining us this morning. I sincerely hope you and your families are healthy. We look forward to returning to some semblance of normalcy and we'll really welcome the day we can meet with all of you again in person. Despite the many distractions of COVID-19, we had a very solid first quarter. Adjusted revenue including the acquisitions of DRG for one month and Darts-ip, excluding the divested MarkMonitor businesses increased by 10.5% to $243 million at constant currency. In addition to recent acquisitions, revenue growth was driven by new business and price increases. Subscription revenue excluding divestitures increased 8.4%. As a result of temporary work stream disruptions experienced by a few of our customers due to the virus, we did experience some delay in getting a few contracts renewed during the quarter. We expect these contracts to be renewed in Q2 and consider this a timing issue. Adjusted total company organic revenue growth at a constant currency was 2.2% and was affected by the timing of the contract renewals I just mentioned. Our efforts to improve our operational and financial performance are delivering results, as demonstrated by the 32% increase in adjusted EBITDA to $78 million. This drove an almost 700 basis point improvement in our first quarter margin to 32.2% and we benefited from revenue growth, acquisitions, portfolio rationalization, and cost savings initiatives. Richard will cover the financials in detail in a few moments. During the first quarter we continued to make enhancements to our product offerings across our portfolio. Within our Science Group, beyond the DRG integration work we launched Cortellis Drug Discovery Intelligence as the successor platform to Integrity, which was well received by the market. We also released Cortellis Generics Intelligence, the new version of Newport. Within the Intellectual Property Group, we successfully launched the Derwent Patents database platform with a new user interface and an improved experience. This was very well received by our customers, and we expect the improvement in user interface and workflow to lead us into new buying centers to drive further growth. The integration of SequenceBase, a third quarter 2019 tuck-in acquisition for the patent business, added new functionalities and is progressing well with completion expected by the end of the second quarter. We also completed the integration of Darts-ip, a business we acquired last year's fourth quarter within the CompuMark product suite. We continue to drive product enhancements across the portfolio, and I'm pleased to report there's been no disruption to our product development roadmaps. This week we will launch our first Customer Delight and colleague engagement surveys for 2020. Our colleagues’ engagement and Customer Delight focus is the way I’ve always led companies toward faster profitable growth. These surveys will identify actions for us to take that we expect will make a significant difference in driving our performance. We look forward to sharing those results with you on our second quarter earnings call. In February, we closed the acquisition of DRG and immediately kicked off integration activities. While most of our company is currently in a work-from-home status due to the health pandemic, I’m pleased our team has not slowed down the integration work at all. They're ensuring the capture and realization of cost and revenue synergies. The team is focusing on a seamless transition and the protection of existing businesses. We remain on track to meet our cost synergy target of $10 million in 2020 and to meet our $30 million run rate synergy target over the first 18 months of our ownership. On the revenue side, our sales teams are excited about cross-selling initiatives to drive revenue synergies, and early interest from customers is very promising. Turning to the COVID-19 pandemic, I couldn’t be prouder of how we, as a company, have responded during this crisis. The collaboration across Clarivate has been outstanding. During times of crisis, the company’s commitment and values are tested, and I can attest that my colleagues are truly going above and beyond. We saw early effects of the pandemic in our business in China, which we highlighted on our last earnings call in late February. Since then, the pandemic quickly swept across the world. We immediately took steps to ensure the health and safety of our colleagues by implementing social distancing and moving all of our colleagues to work-from-home status. Thanks to a well-planned transition, this global team has managed to meet or exceed its productivity and service level agreements. We do have the capability for 100% of our workforce to work seamlessly from home. We have developed a return-to-work plan and safety protocols for when other regions begin to relax stay-at-home restrictions. We’re proud that during these unprecedented times, we’ve not missed a beat in collecting and processing content. Our colleagues were operational within a few days. The content teams are processing a high volume of material across our business groups. We’re seeing workflow increase due to large volumes of information from various sources, including the Chinese patent office, press releases, pharmaceutical pipeline data, and financial deals. We’re working closely with our customers to meet their needs, and I'm delighted to report there’s been no disruption to any services we provide to them. Our industry-leading portfolio of products is available online and can be accessed from anywhere. We’re also doing our part to assist in COVID-related research. This aligns with our purpose as a company; we believe human ingenuity can transform the world and improve our future. While we regularly work with many large pharmaceutical companies and governments, our consultants and professional services teams are also working with them on COVID-related projects. We are supporting researchers with our COVID-19 website, making research readily available for not-for-profit researchers to reference existing work. Our Cortellis product is playing an important role, covering all COVID-related trials. We delivered significant retrospective coverage in March for all available trials from all registries, representing 969 trials. As we recover from the pandemic, we believe there will be increased interest in our products, particularly within life sciences. Lastly, we expect to see more new opportunities for our business than ever before. This morning, we reaffirmed our 2020 outlook for adjusted EBITDA of $395 million to $420 million, adjusted EPS of $0.53 to $0.59, and adjusted free cash flow of $220 million to $240 million. We evaluated various scenarios based on what we currently know. Our scenarios include that the COVID virus is brought under control late in the second quarter, that there is a gradual lifting of restrictions, and that we begin to see a pickup in economic activity early in the fourth quarter. We’re optimistic that the health crisis will improve in the coming months. If, however, we do not see improvement, we are prepared to take additional actions as needed. But we know that our business has numerous competitive advantages that insulate us and help us weather the current environment. Our products and services are essential, not nice to have. Our customers rely on us and our solutions are essential. We have more than 18,000 customers. We sell into durable end markets, including government, research institutions, and life science companies. We are a highly resilient company with approximately 80% of our revenue from recurring subscription streams. We maintain strong revenue retention rates currently around 93% and we have low levels of capital intensity and low cash taxes. While we maintained our outlook on profitability, we revised our revenue outlook down by 2.5% at the midpoint compared to prior guidance. During the first quarter, we granted our colleagues salary increases effective April 1st. We do not plan to have any layoffs, aside from previously announced redundancies. We also introduced a company-wide shareholder program based on customer delight goals. Our people are a sustainable advantage, and we’re fortunate to have truly great colleagues. To offset revenue softness and maintain our EBITDA guidance, we've implemented approximately $30 million of new cost savings measures for 2020, $5 million of which we expect to be permanent. Savings include a hiring freeze, no travel policy, and reducing certain non-critical SG&A expenses. These savings are in addition to the cost optimization program already underway to deliver $45 million of savings in 2020 and $70 million to $75 million on a run basis as we exit the first quarter of 2021. Combined with the DRG synergy savings of approximately $30 million, we expect to achieve $110 million in permanent cost savings over two years. Importantly, we’re doing this without impacting the way we do business or our ability to continue our investment in R&D. We believe we’ll remain within the EBITDA range we provided in February. While the current environment presents many challenges, we will be even better positioned to achieve our long-term objectives, including driving towards our goals of exiting 2020 with 6% to 8% organic revenue growth and adjusted EBITDA margins of 37% to 40%. I'll now turn the call over to Richard.

Thank you, Jerre. We delivered a very good first quarter to start the year, which is impressive given the current stay-at-home orders. We reported adjusted revenues of $243 million, an increase of $8 million or 4% at constant currency. The first quarter includes a one-month contribution from the acquisition of DRG and a full quarter from Darts-ip, which together added 8% to revenue growth. This was offset by the divested products sold on January 1st of this year, which reduced revenue by 6% compared to last year's first quarter. As a reminder, we divested these product lines because they were subscale, capital intensive, and low margin. Excluding these product lines, total revenue increased by 10.5% at constant currency in the first quarter. With a large percentage of our revenues being U.S. dollar-denominated, there was less than a 1% negative impact from foreign exchange due to dollar strength compared to last year's first quarter. The EBITDA impact from FX is minimal in the first quarter due to our company’s natural hedge. Ongoing business revenue, excluding acquisitions, divestitures, and foreign exchange increased 2%. Total subscription revenue was $193 million, which increased 8% at constant currency. Ongoing business subscription revenue grew 3% in the first quarter, driven by new business and price increases consistent with growth in the annualized contract value. As Jerre mentioned, subscription revenue growth was partly impacted by the timing of some renewals due to the pandemic; these timing issues will result in some subscription revenue being pushed from Q1 into Q2. On a reported basis, subscription revenue increased by $0.7 million, a 1% increase at constant currency. Recent acquisitions added 5% of subscription revenue growth but were offset by the divested product lines, which decreased subscription revenue by 7%. Subscription renewal rates were 93% in the first quarter, consistent with the prior year, although slightly affected by timing. Transactional revenue increased to $49 million, up $7.5 million or 18% year-over-year, driven by the acquisitions. Recent acquisitions added 23% of transactional revenue growth, while product line divestitures reduced transactional revenues by less than 2%. Ongoing transactional business revenues decreased by 3% due to slightly lower search volumes in certain areas. Adjusted free cash flow was $78 million in the quarter, an increase of $14 million compared to last year’s first quarter due to improved working capital management. As of March 31, we have total gross debt of $1.96 billion. This includes $360 million of borrowings related to the DRG acquisition, which is a senior secured term loan B issued at par with an interest rate consistent with our existing term loan facility. Net debt was $1.65 billion. We are required to report standalone adjusted EBITDA on a trailing 12-month basis according to reporting covenants in our credit agreements. Standalone adjusted EBITDA was $425 million, driven by an increase in adjusted EBITDA. We ended the quarter with significant liquidity, including $308 million of cash and an untapped revolver of $250 million. With forecasted adjusted free cash flow of approximately $220 million to $240 million this year, we have the resources to reduce debt and continue investing in accretive M&A opportunities.

Thanks, Richard. Great job. Before we open the lines for questions, let me reiterate that we're well positioned to manage through the current environment. We have a suite of healthcare, science, and IP products that are essential to our customers. This year, we expect to generate over $200 million of free cash flow, allowing us to continue investing internally, reduce our debt, and invest in business development and M&A. Next week, we’ll celebrate our one-year anniversary as a public company. I’m proud of what we've accomplished over the past year. Beyond operational and financial growth, we’ve been enhancing our corporate governance. Our Board is transitioning to an independent Board with independent committees. This year we will continue to evolve by introducing a sustainability program to focus on our impact on the environment, our society, our customers, and our communities. I want to thank my colleagues at Clarivate for their dedication and hard work as we manage through this global health crisis. I also want to thank our customers for their continued support. Lastly, due to the health crisis, we’ve moved our 2020 Investor Day scheduled for May 19th to September 22nd. Please mark your calendars for a thorough review of Clarivate and our profitable growth strategy. We’re ready to take your questions. As a reminder, please limit yourself to one question before returning to the queue. Thank you.

First question comes from Seth Weber of RBC Capital Markets. Please go ahead.

Hey, guys. Good morning. I hope everybody is doing well. I wanted to ask about the pricing environment, just given the obvious challenges in the macro landscape. Jerre, you had previously talked about targeting a bit over 3% for 2020. Is that still a good number to think about, and could you provide any additional color on the two verticals, science versus IP, on the pricing side? Thank you.

Sure. Great question, Seth. Yes, we’d previously discussed projecting around 3.2% for 2020. Last year, we did about 2.1% to 2.2%. Just a reminder for everyone, 50% of our annual subscription base has renewed in Q1, 20% in Q2. The only exceptions we’ve made on pricing occurred in some countries where the dollar is much stronger, as much as 25% to 30% stronger compared to last year. Hence, we’ve taken the currency issues into account as 80% plus of our renewals occur in dollars. I feel confident in this regard. We will gather more input, which we’ll provide you at the end of Q2, particularly from our Customer Delight surveys that are starting today. Thanks, Seth. Next question.

The next question comes from Andrew Nicholas of William Blair. Please go ahead.

Hi, good morning.

Hi.

Good morning. Can you speak to the health of your Web of Science customer base specifically, and the extent to which you expect budgetary pressures on universities to affect those sales conversations - whether in terms of renewal rates or other factors? I’m particularly interested in the next couple of years. Thanks.

Yeah, that’s a great question. I’ll start, Mukhtar will follow up. We measure usage metrics every day for each of our products. Usage of Web of Science has significantly increased, which aligns with the vast number of universities conducting online education. Point one. Point two, we’re a critical part of universities’ investments and help them make larger spending decisions. Mukhtar, please add.

Sure. Thank you, Jerre. I think the outlook remains strong for us. We’re the industry’s leading benchmark for evaluating research within academia, and we expect that to continue. Universities are likely to adapt their business models by shifting to distance learning, which aligns well with the use of Web of Science and our data assets for virtual communities and collaborations. This positions us strongly moving forward.

Thanks, Mukhtar. I’d like to add that we’ve established a team led by Richard along with Jeff and Mukhtar to review any requested changes in terms regularly, as any expected issues would likely be most pronounced in Web of Science. They have been meeting twice a week, and I can share that so far disruptions have been minimal. I am very pleased with this aspect of our operations. Thank you. Next question.

Thank you, sir. The next question comes from Ashwin Shirvaikar of Citi. Please go ahead.

Thank you. Hi, Jerre. Hi, Richard.

How are you?

I’m good, thanks! Hope you’re doing well in the current environment. My question is regarding intermediate to long-term revenue opportunities. Based on your remarks, the subscription revenue shortfall should catch up in Q2. However, the full-year shortfall might come from transactional revenues like Web of Science, backfile sales, and such. Can you discuss client conversations regarding these sales in the intermediate to longer term, including opportunities in areas like epidemiology research?

That’s a fantastic question. Our weekly calls with all colleagues worldwide help us stay informed about issues like this. We believe that we will exit 2021 with an 8% to 10% organic level, with strong growth in life sciences. Mukhtar, could you expand on that?

First, we’ve maintained full continuity of all operations, including sales operations, customer engagement, and our data operations. What’s outside our control are specific government policies surrounding economies. As those economies open up, we’re ready to respond. We’re in constant contact with our customers. For services, we’ve transitioned from onsite delivery to remote service delivery. Continuity has been a priority during this time.

Thanks, Mukhtar. Jeff, would you like to add something?

I’d highlight that for the IP business, the pharma segment is still critical for us, and we do quite a bit of business there. While we might see some backtracking on one-off transactions like trademark filings due to the macro situation, we possess a strong and diverse product mix. Our competitive position remains healthy; investing in and protecting IP during challenging times is crucial.

Great. Thanks, Jeff. Next question, please.

The next question comes from George Tong of Goldman Sachs. Please go ahead.

Hi, thanks. Good morning. You’ve slightly adjusted your revenue guidance to reflect the impact of the coronavirus. Can you deconstruct the revenue guidance update in terms of changes to assumptions around pricing, retention, new sales, and timing and the expected impact across your science and IP product groups?

I’ll start, and Richard can follow. We revised the midpoint by less than 2.5%. A significant portion of that drop reflects a slowdown in one-off transactional businesses. There was softness specifically on patent and trademark searches. Interestingly, the one-off transactions ended somewhat stronger than we anticipated. The primary reason for the $30 million midpoint drop is due to timing; we won’t see that fully come back in 2020, but we will expect it in 2021. Richard, please continue.

Thanks, George. When looking at the 2.5% adjustment from the midpoint, approximately one quarter of that is from subscription revenue. We’re taking a cautious view as concerns over new business are not surprising. The bulk, about 75%, comes from transactional revenue streams, including professional services. That’s the approximate split between the two main revenue drivers.

To add further context, we were fortunate to receive early indicators from China and had a thorough review of potential impacts. It was reassuring to see close alignment between all teams. The assurance increases each month on our future trajectory. Richard’s earlier description about a modest shift in the annual subscription base is accurate. We’re keeping fluctuations from currency exchange rates in mind. I feel more confident about where we stand now. Thanks, George. Next question.

Thank you. The next question comes from Shlomo Rosenbaum of Stifel. Please go ahead.

Good morning. Thank you for taking my question. Jerre, can you talk about the acquisition impact, particularly for DRG, which had a considerable fraction of consulting revenue? How is that performing now, and to what degree is the $30 million revenue reduction temporary due to declines in consulting revenue from DRG?

Great question. Mukhtar and the team are doing an amazing job with the DRG acquisition integration. We hold weekly meetings to ensure it’s progressing well in this environment. I believe we have a strong standing with DRG, and I’d like Richard and Mukhtar to elaborate on potential losses we might see in consulting.

Good morning, Shlomo. Thanks for your question. We’ve been impressed with DRG's robustness. The life sciences sector is currently a strong area to sell into. DRG's long-term client relationships have mitigated disruptions, and overall progress is favorable.

Yes, Richard summarized it well. The revenue and cost synergy plans from DRG are on track, and the integration has proceeded smoothly. The majority of our revenue comes from recurring long-term relationships, and we’ve transitioned from onsite to remote consulting delivery, maintaining continuity.

Thanks, Mukhtar. Next question please.

The next question comes from Zach Cummins of B. Riley FBR. Please go ahead.

Hi, good morning, Jerre and Richard. Thanks for taking my question.

Hi, Zach.

It seems you have some tailwinds in the life sciences sector. Can you remind us how the other portions of your business typically operate in a recessionary environment?

Great question. Historically, during the last major economic downturn from late 2007 to 2009, our businesses either remained flat or experienced slight growth. Considering our advancements since then, we’re in a far better position today. We’re integrated into our customers’ workflows. They need our assistance more than ever during these challenging times.

While historical data can be complex, the resilience of our Web of Science business over the years shines through. In the current context, our content holds even greater value to the scientific community than ever before. We anticipate greater demand for Web of Science after this situation passes.

Thanks. Jeff, do you want to add anything?

For the IP business, the pharma segment remains critical, and we maintain significant business there. Some reductions may occur in non-recurring transactional areas during a poor macro environment, but our diverse product mix and commitment to protecting IP enables us to weather challenges effectively.

Thanks, Zach. Next question.

The next question comes from Peter Christiansen of Citi. Please go ahead.

Thank you. Good morning, gentlemen.

Hi.

I was hoping you could talk about any noticeable changes in user engagement as you moved into April, in terms of log-ins or time spent on the platform by product category. I think that would be helpful. Thank you.

To simplify, we measure daily input, which is critical for us, and output. Every product has either increased or remained stable, and we’re observing higher input overall. The productivity of our colleagues has shown some improvement as users engage better while working from home. We are optimistic that this engagement will persist when employees return to the workplace. Thanks. Next question.

And our last question today will be a follow-up from Seth Weber of RBC Capital Markets. Please go ahead.

Hi. Thanks for taking the follow-up. I wanted to ask about China beginning to stabilize and coming out of this situation. Can that serve as a parallel for how you think the rest of the world will react, based on lessons learned there?

Thanks, Seth, that’s an insightful question. We were fortunate to have early insights from our operations in Asia, which allowed us to prepare proactively. Learning from our experiences in China, we established continuous updates with teams worldwide. Overall, the adjustment and teamwork displayed have been commendable. Regarding our return to office strategy, we will wait at least three weeks after the government makes a decision before we act. I believe the team has performed exceptionally, and I am optimistic about our position moving forward, particularly through the remainder of 2020 and into 2021, where I’ve never felt more excited about our trajectory. Thank you for joining us this morning. I wish you all well and look forward to further updates. Thank you, operator.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.