Earnings Call Transcript - CLVT Q2 2024

Operator, Moderator

Good morning. Thank you for attending the Clarivate Q2 2024 Earnings Conference Call. My name is Alyssa and I will be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. I would now like to pass the call to our host, Mark Donohue, Vice President Investor Relations. Please go ahead.

Mark Donohue, Vice President Investor Relations

Thank you and good morning, everyone. Thank you for joining us for the Clarivate second quarter 2024 earnings conference call. As a reminder, this conference call is being recorded and webcast and is copyrighted property of Clarivate. Any rebroadcast of this information, in whole or in part without prior consent of Clarivate is prohibited. The accompanying earnings call presentation is available in the Investor Relations section of the company's website. During our call, we make certain forward-looking statements within the meaning of the applicable securities laws. Such forward-looking statements involve risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the business or developments in Clarivate's industry to differ materially from the anticipated results. Information about the factors causing actual results to differ materially from anticipated results can be found in Clarivate's filings with the SEC and on the company's website. Our discussion will include non-GAAP measures or adjusted numbers. Clarivate believes non-GAAP results are useful to enhance an understanding of our ongoing operating performance, but they are supplementary and should not be considered in isolation from or as substitutes for GAAP financial measures. Reconciliation of these measures to GAAP measures are available in our earnings release and supplemental presentation on our website. With me today are Andy Snyder, Chairman of the Board, Jonathan Gear, Chief Executive Officer, Matti Shem Tov, our new incoming Chief Executive Officer, and Jonathan Collins, Chief Financial Officer. After our prepared remarks, we'll open up the call to your questions. And with that, it's a pleasure to turn the call over to Andy Snyder.

Andrew Snyder, Chairman of the Board

Thanks, Mark and hello, everyone. Thanks for joining us this morning. With today's news, I would like to first take this opportunity to thank Jonathan Gear for his leadership at Clarivate. I know I'm speaking for the entire board when I say we are grateful for Jonathan's many contributions to the company. Jonathan joined Clarivate during a challenging time for the business. During his tenure, he has been instrumental in restructuring and strengthening our organization, laying the foundation for the next phase of Clarivate's value creation journey. We've had many productive conversations and Jonathan and the board have determined that now is the right time to transition the leadership of Clarivate. We're grateful that Jonathan has agreed to assist in the transition in a non-executive role after he steps down as CEO. I want to be clear about one thing: the foundation of our businesses is strong and our future remains bright. Over the past three years, I've had an up-close view into Clarivate's operations, strategy, and growth opportunities as a member of the board. It's clear to me that we have a tremendous senior leadership team and that there are many growth opportunities ahead. Looking ahead, we are very pleased that Matti Shem Tov will be joining Clarivate as our next CEO. He will be an important driver of the long-term success of Clarivate. I've had the privilege of working with Matti at ProQuest, where he was CEO for nearly five years. I've seen firsthand the positive impact he's had, driving value across an organization. I'm certain Matti will leverage his deep expertise and people-first leadership style to build on Clarivate's many successes by driving execution and performance to deliver profitable growth, increase product innovation, and drive value creation for all stakeholders. Given Matti's decades of leadership experience, the board and I are confident that he is well-suited to partner with our senior management team to lead Clarivate during the next phase of its growth. With that, it's my pleasure to turn the call to Matti.

Matti Shem Tov, Incoming Chief Executive Officer

Thank you, Andy. Good morning, everyone. It is an honor to be back at Clarivate. I want to thank Andy and the board of directors for the opportunity to lead Clarivate during the next phase of its growth cycle. As you may know, I ran both ProQuest and Ex Libris for many years, and I left following the Clarivate acquisition of ProQuest in December 2021. Since then, I have been following Clarivate closely, and I have been truly impressed, which played a large part in my decision to return to the company. I'm pleased that Clarivate has reorganized into three segments to put extra attention and funding towards innovation and customer engagement. Equally important to me, Clarivate has developed great talent across the organization and has a rich portfolio of world-class industry-leading products and assets. As I rejoined the company, I'm planning to immerse myself back into the business and speak with colleagues from around the world to gain feedback on how we can become an even better and more effective company. I will also be engaging our customers and partners to understand their needs and how we can better serve them. I'm confident that with some adjustments, we can build on what Jonathan and the leadership team have accomplished and take Clarivate to the next level. I want to thank Jonathan Gear for his leadership while steering the company through the turnaround. As Andy stated, Clarivate is in a much better position today because of your leadership, Jonathan, and I look forward to working with you during the transition phase. And I’ll pass this over to Jonathan.

Jonathan Gear, Chief Executive Officer

Great, thank you, Matti, and good morning, everyone, and thanks for joining us today. On our last earnings call, I spoke about our success in making the necessary operational and product progress to revitalize our business and set a clear path to achieve our plan. I reiterated our commitment to create a clear executional plan to deliver on our long-term growth objectives. Looking ahead, with its accomplishments behind us and the incredible opportunity Clarivate ahead, the board and I have mutually agreed that now is the right time for this change. Clarivate is in a strong position today. During my time as CEO, we restructured the company into three end market segments and reinvigorated our product innovation investments and commitment to our customers. We have built a tremendous and talented team that is well-positioned to steer the company to the next level. I'm incredibly proud of all the work our colleagues have done to get us to this point, and I feel stronger than ever. The future of Clarivate is bright, and the best is ahead. As I step down from my role as CEO and transition into a non-executive role within the company, I will be handing the reins over to Matti this coming Friday. The board and I have full confidence in his ability to lead the company, and I look forward to continuing to work with Matti to help ensure a seamless transition so the company does not miss a beat. Turning to our second-quarter results, we delivered slightly better results compared to our previously announced expectations with organic revenue growth down less than 1%. This represented a sequential improvement compared to this year's first quarter. We continue to focus on efficiently managing the business during the turnaround period at Clarivate, resulting in solid profitability and strong free cash flow. Jonathan Collins will cover the quarterly results in more detail shortly. We're now moving on to the review of our segments starting with academia and government. For the first half of this year, A&G subscription growth increased more than 3%. This was driven by an improvement of our renewal rates to more than 96%, a best-in-class level, driven by the improvements and investments in Web of Science. Transactional sales within A&G have faced some headwinds across digital collections and books due to softer one-time budgets in the recent academic fiscal year. As you remember, we began seeing the softness in Q4 of last year and it has continued now through the first half of this year. Our commercial team is working closely with our customers to maximize the value they receive without impacting their budget needs. We are driving new product innovation and AI functionality by leveraging our deep knowledge and expertise across the A&G marketplace. This will help us win new business and deliver better performance in the future. Our goal is to drive soft growth above 4% by launching new products in the research intelligence and software space. I'm pleased to share that we've made great progress within these areas this quarter. We've strengthened our research offerings with the recent launch of AI-powered Web of Science Research Intelligence. This is a transformational AI-native software solution that will empower researchers to accelerate innovation and research institutions to better measure and showcase the impact of their research. We also launched two new software solutions, Collecto and Specto. Collecto enables librarians to more effectively and efficiently manage collections with improved analytics, unified platform, and AI. While Specto showcases all library digital collections through generative AI, improved workflows, and guaranteed long-term access. Our focus on enhancing products and creating new solutions is beginning to translate into wins across the marketplace. For example, we won a large statewide multi-year content aggregation deal, which displaced a key competitor. We were also awarded a library software deal covering over 2000 school libraries in Europe. Moving to the IP segment, on our last year's call, I talked about the turnaround within this segment. I am very pleased that we're starting to see improved performance following a challenging year in 2023. Year-to-date, we have delivered high single-digit revenue growth within IP management software. This includes an over 80% win rate in large competitive corporate software deals in Japan, which is a key IP market. The macro environment has also improved, stabilizing trademark search volumes and delivering on a few large-scale project wins. The improved performance is expected to drive organic growth across the segment in the second half of this year. We are encouraged by the early signs of a turnaround for Derwent, our patent intelligence product. The product refresh and enhancements are beginning to deliver improved renewal rates, which increased more than 250 basis points compared to the same period last year. On the product development front, we recently launched Trademark Watch Analyzer, a next-gen protection solution which brings together global trademark and case law combined with our IP expertise and cutting-edge AI technology for greater efficiency and accuracy. Our commercial team is learning new business wins. We were recently awarded two multi-year government contracts. This tuck-in acquisition supports our focus on providing IP attorneys with AI-enabled tools to automate parts of the filing and prosecution process. At our Investor Day in March 2023, we piloted specific products requiring investments to reinvigorate growth. Since then, we have made tremendous progress within the IP segment on product refresh and the development of new solutions. These new offerings deliver embedded use case specific intelligence to customers which opens us up to new sales opportunities and a greater share of budgets. I mentioned this positive turnaround at Derwent following the investments we have made. Derwent Search is in premier quality parts of the market and has moved beyond core legal use cases into other departments. Our product engineering efforts have focused on creating solutions that address growing needs. We are excited about the development of a new patent watch solution and a suite of R&D solutions, which will be fully available to customers in the first half of 2025. Turning to the life sciences and healthcare segment, externally, we have been impacted by macro headwinds due to tighter customer budgets. Internally, the needs of product refresh and our decision a year ago to shift our go-to-market strategy with real-world data sales have led to a reduction in our revenue. However, we are starting to see the benefits of our product overall with improved performance in international markets and across mid-size pharma. We recently closed a large consulting deal focused on diabetes and obesity worth over $1 million. We were also awarded our third sale this year of pharma-grade data via our new platform to one of the top 20 pharma companies. In closing, I want to thank my colleagues for their loyalty, hard work, and dedication over the past two years. I also want to thank our customers, shareholders, and our board for their support. I will be clarifying that we are on the right trajectory forward, and the efforts to improve the business will begin to be rewarded in the coming years.

Jonathan Collins, Chief Financial Officer

Thank you, Jonathan, and good morning, everyone. Slide 15 is an overview of our second quarter and first half financial results compared to the same periods from the prior year. Q2 revenue was $650 million, a decrease of $19 million compared to the prior year, bringing the first half to $1.27 billion. Most of the second quarter decline was due to the Valipat divestiture and the stronger U.S. dollar. The second quarter net loss was $317 million, $175 million lower than last year due to the non-cash goodwill impairment charge recorded in the LS&H segment. This was also the primary driver of the first half net loss of $411 million, down $294 million from last year, as the higher impairment was amplified by favorable legal and tax settlements in Q1 last year that did not recur this year. Adjusted diluted EPS, which excludes the impact of one-time items like the impairment and these settlements, was $0.20 in Q2, a $0.01 decline over the same period last year, bringing the first half to $0.34, down $0.05 over the prior year due to lower adjusted EBITDA and higher depreciation and amortization expenses from our increased investments in product innovation. Operating cash flow was $126 million in the quarter, a decrease of $36 million over the second quarter last year, bringing the first half to $302 million, down $88 million over the prior year. The decline is mostly driven by timing differences in working capital as the lower adjusted EBITDA was offset by lower one-time costs. Please turn with me now to page 16 for a closer look at the drivers of the second quarter, top and bottom line changes from the prior year. Free cash flow was $60 million in the second quarter, a decrease of $44 million over the same period the prior year, driven largely by timing differences in working capital. This brings first half free cash flow to $172 million, a conversion of 34% on adjusted EBITDA, which is about five percentage points lower than our full-year expectation due to the timing of our working capital requirements. The net impact of these changes is that free cash will likely come in near the low end of the guidance range. As we move into next year and we touched on this just a moment ago, the investments that we're making in product that are coming into general release in the second half of this year are products that should generate subscription revenues. So we do expect to see the benefit in ACV as we move into next year. The acceleration of our organic growth will be led by the subscription business and the investments we are making in those types of products.

Operator, Moderator

Thank you. We will now start the question and answer session. The first question is from Toni Kaplan with Morgan Stanley. Please go ahead.

Toni Kaplan, Analyst

Thank you so much. You talked about life science and healthcare needing to improve in the second half and there's a backlog of larger projects. In the current environment where you've seen these tighter budgets, I guess how should we think about the confidence in delivering on these projects versus maybe them getting pushed out to next year? And any color on sort of the win rate you're expecting with these versus what's needed in the guide? So win rate on large projects within LS&H now versus what's needed to meet the guide.

Jonathan Gear, Chief Executive Officer

Thanks. Sure, thanks Toni. This is Jonathan. Yes, in the second half of the year, from the areas that we've seen some pressure, actually our consulting practices held up pretty well. We have pretty good line of sight in there to the project backlog through the balance of the year. The fact that Q4 of last year was a bit softer certainly helps on the comp. So, I think that's an area where we have a pretty decent line of sight and feel pretty comfortable that even in an environment where budgets are tighter, that's a part of the business that's going to hold up reasonably well in the second half of 2024.

Mark Donohue, Vice President Investor Relations

Thank you, Toni. Next question, please.

Manav Patnaik, Analyst

Thank you. Good morning. Firstly, Matti, welcome back, looking forward to talking again and Jonathan, hopefully our paths will cross again. But I was just hoping, you know, Andy, if you could maybe just help us a little bit more with the CEO change. I think all of you have said in your prepared remarks that Clarivate is in a very strong shape, ready to grow. It seems like everything's looking upwards. And, Matti has a strong background in the A&G segment given its history. But just a little bit more color and what does this say about the other two segments going forward, please?

Jonathan Gear, Chief Executive Officer

Thank you, Manav, for the question. It’s great to connect again. First, I want to highlight that while Matti has extensive experience in the A&G segments, he has also consistently shown an ability to execute effectively and enhance performance across various businesses. We have spent considerable time with Jonathan discussing the future direction of the company and reached a consensus that now is the appropriate moment for a transition. Our primary focus is on enhancing execution and performance across all business segments, and we believe that Matti is ideally suited to lead this initiative throughout the company.

Mark Donohue, Vice President Investor Relations

Thanks, Manav. Next question, please.

Surinder Thind, Analyst

Thank you. In terms, just strategically, as we look ahead, is the idea to be more product focused, faster product cycles. And then just maybe any color and the fact that it sounds from the commentary that there's a lot of product coming in 2025 and how we should think about that translating to growth?

Jonathan Gear, Chief Executive Officer

I would like to address the first point. I feel confident about our direction. When I joined two years ago, a significant theme was the need for increased focus on innovation and preemptive growth investments. We've been implementing this strategy across all three segments we have discussed. Currently, we're starting to see the positive results of our innovation through new product launches. For instance, the enhancements made to the Web of Science are reflecting the value of our investments in that product. Additionally, we highlighted various examples in intellectual property, life sciences, and healthcare during today’s presentation. I view this as a developing trend that has been growing over the past couple of years. We have experienced initial successes in A&G, and we are now observing an uptick in Derwent renewal rates. The first half of this year has continued to reinforce these trends. Therefore, I anticipate this growth to persist. Following our innovation, we expect to see higher customer engagement, leading to increased revenues. This is fundamental to the improvements in the long-term strategy we have discussed previously.

Jonathan Collins, Chief Financial Officer

No, it's great.

Mark Donohue, Vice President Investor Relations

Thanks, Surinder. Next question, please.

Shlomo Rosenbaum, Analyst

Hi, thank you very much. I just wanted to talk a little bit about Derwent and just the whole overall IP growth trajectory. And it seems like at least the private companies in this space seem to be having more success based on at least some comments that I've heard from them. And I'm wondering if you feel that you're just losing ground competitively over there. And if so, do you feel like that's being turned around? And then I just thought I would ask Matti to just comment a little bit about his confidence in being able to execute on the growth plan or whether he thinks there's going to be a complete strategic review and maybe come out with a different plan to the street?

Jonathan Gear, Chief Executive Officer

Great, and this is Jonathan. I'll go ahead and comment on this. I mean, your comments on IP are great. I feel confident in the turnaround of the IP business in particular. I think your comment on losing ground. That was certainly true two years ago. And in my comments today, I talked about our improved win rate on IPMS, the 80% competitive win rate in Japan. Frankly, two years ago, we were on our back heels, now we're on our toes. And that is a critical early indicator for us in IP. When you win an IPMS system, you implement an app for 12 months, then you get back revenue. This gives you a far greater likelihood of winning the much larger annuities on the back of that. So this is something which quite frankly hurt us two years ago when we were losing some of these IPMS systems. We're now winning more than our fair share. It does take 12 to 18 months to convert into revenue and its totality of the opportunity. But I feel this confidence in what the team has done leading IP with more to come there. And then I'll probably intercept your question for Matti. Let's give Matti 90 days to get his head around the business and then he can come back in his call and comment on his views. Thank you.

Mark Donohue, Vice President Investor Relations

Thanks, Jonathan. Next question, please.

Wahid Amin, Analyst

Good morning. It's Wahid Amin on for Heather. I want to dial in on ACV. As you're adding more products and seeing new client wins, what level do you expect ACV to grow and what more can you do in the space to grow that metric?

Jonathan Collins, Chief Financial Officer

Yes. That's a great point. This is Jonathan Collins. As we move into next year, and we touched on this just a moment ago, the investments that we're making in product that are coming into general release in the second half of this year are products that should generate subscription revenues. So we do expect to see the benefit in ACV as we move into next year. Just as a reminder, Jonathan walked through the four different applications for personas that we'll be serving in patent intelligence going forward. The first of those will go into general release this year. We expect that to start to help our renewal rates, creating great opportunities for upselling those products as we move into next year as well. So the acceleration of our organic growth will be led by the subscription business and the investments that we're making in those types of products.

Mark Donohue, Vice President Investor Relations

Thank you. Next question, please.

Owen Lau, Analyst

Good morning and thank you for taking my question. So, on the more balanced approach to use free cash flow, could you please add more color on how much do you expect for organic growth, M&A, buybacks, and how much would be leveraging? And do you have a new target for your leverage in the near and longer term? Thanks.

Jonathan Collins, Chief Financial Officer

Thanks, Owen, this is Jonathan. So what we really want to convey here is that over the course of the past couple of years, leveraging has been our primary objective within our capital allocation. Now that we've got leverage under four terms, we are pivoting a bit, and we see a greater opportunity to repurchase our stock at lower levels. But also, it's really important to highlight that we're starting to see green shoots in each of our three segments, where there's an opportunity to put capital to work, to acquire new capabilities that we think will also help to catalyze organic growth in the next couple of years. So I don't have specific numbers for you for the second half of the year, but we want to make sure that it's clear that that objective that we've had to get our leverage under four terms, we've really achieved, and now we see ourselves being in a more flexible position to either buy back stock or acquire smaller businesses that will help to accelerate our growth.

Mark Donohue, Vice President Investor Relations

Thanks, Owen. Next question, please.

Andrew Nicholas, Analyst

Hi, good morning. Thank you for taking my question. I wanted to ask a little bit more on guidance. I think on the fourth quarter call, Jonathan, you gave segment-level growth expectations. Curious if those have changed meaningfully from earlier this year. And then also, if you could just kind of outline what you're thinking about or embedding in guidance in terms of macroeconomic conditions, whether it's patent volumes, budget constraints, any expected recovery that's baked in, or would you need to see deterioration for there to be risk to the bottom end of the guide? Thank you.

Jonathan Collins, Chief Financial Officer

Yes, you got it, Andrew. So maybe I'll start with a macro first. I think the area that we've seen a bit more softness and maybe we anticipated at the beginning of the year is within life sciences and healthcare, as Jonathan touched on in his prepared remarks. We continue to see budget pressures at some of our largest customers which are very important for this segment. So from a macro standpoint, that's really the only change that we've seen from the beginning of the year. When we think about it from a segment perspective, A&G's subscription growth is generally going to be in line with what we originally expected. The slightly lower expectations on subscription revenue are really going to come in the life sciences and IP business, and the macro within life sciences is the real driver there. Certainly, the recurring revenue change, we think we're going to be flat now instead of up a percent. That's essentially all in IP. And then our transactional expectations on the full year really haven't moved meaningfully, but that's a little bit of shaping and color on each of the segments, and we'll of course give more of an update in a few months as we complete the third quarter.

Mark Donohue, Vice President Investor Relations

Thanks, Andrew. Next question, please.

Ashish Sabadra, Analyst

Thanks for taking my question. I just wanted to drill down further on the subscription growth, which is now expected to be below 2% due to that softness in life sciences and IP. Just wondering how much of that has been driven by some of the macro headwind like the budget pressure and how much of it potentially is due to a slower adoption of some of these newer products being launched?

Jonathan Collins, Chief Financial Officer

Yes, thanks for that question, Ashish. Within life sciences, it is, we believe it's mostly the macro we think we've accommodated for some of the product challenges and investments that we're making there. I think on the IP side, while Jonathan highlighted real strength in Derwent's renewal rates, which is a good leading indicator, the patent intelligence segment is softer than we would have expected with products like Innography and Incopat. And as you'll recall, as Jonathan laid out the investment we're making there, Derwent, the search and watch use cases are getting the investment first and Innography and Incopat are coming second or a bit later. So that's probably a product area that we're focused on moving into next year. But yes, the macro on the life sciences side and then continued work that we need to do in patent intelligence to get the same leading indicator swings from Innography and Incopat that we're seeing in Derwent.

Mark Donohue, Vice President Investor Relations

Thanks, Ashish. Next question, please.

George Tong, Analyst

Hi, thanks. Good morning. Jonathan, you mentioned that lower industry volumes in the US PTO contract delay were partly responsible for the full year organic growth coming in the bottom half of the range. Can you unpack these a little bit more and whether there were other factors causing you to update your full year outlook for organic growth?

Jonathan Gear, Chief Executive Officer

Sure, George. We think about pointing towards the lower end versus the mid; the subscription business we talked about. You're touching on the recurring order type. We originally thought that would be up about a percent. We think it's going to be about flat. It's widely publicized that we had won a contract at the US PTO referred to as the PCP. That has been delayed until next year. That's really the primary driver of why we think that the recurring order type is going to come in. Just a little bit lower industry volumes and lower FX volatility have had a small impact, but the big driver is the delay of that contract.

Mark Donohue, Vice President Investor Relations

Thank you, George.

Jonathan Gear, Chief Executive Officer

Thank you, George. Okay, everyone again, thanks so much for joining the call this morning. We really appreciate the interest that you have in Clarivate and our remarks. Congrats, Matti, for taking over CEO; this is a great company with a lot ahead of it. I look forward to talking with all of you soon. Take care now, bye-bye.

Operator, Moderator

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.