Earnings Call Transcript - SSNC Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the SS&C Technologies Second Quarter 2022 Earnings Conference Call. It is now my pleasure to turn today's call over to Justine Stone, Head of Investor Relations. Please go ahead.

Justine Stone, Head of Investor Relations

Hi, everyone. Welcome and thank you for joining us for our Q2 2022 earnings call. I’m Justine Stone, Investor Relations for SS&C Technologies. With me today is Bill Stone, Chairman and Chief Executive Officer; Rahul Kanwar, President and Chief Operating Officer; and Patrick Pedonti, our Chief Financial Officer. Before we get started, let's review the safe harbor statement. Please note that various remarks we make today about future expectations, plans and prospects, including the financial outlook we provide, constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our most recent annual report on Form 10-K, which is on file with the SEC and can also be accessed on our website. These forward-looking statements represent our expectations only as of today, July 27, 2022. While the company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. During today's call, we will be referring to certain non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to comparable GAAP financial measures is included in today's earnings release, which is located in the Investor Relations section of our website at www.ssctech.com. In the third quarter 2021, we entered into a joint venture named DomaniRx LLC, in which we are the majority interest holder and primary beneficiary. All earnings figures discussed today, including operating income, EBITDA, net income and EPS are attributable to SS&C based on the ownership interest retained by SS&C. I will now turn the call over to Bill.

Bill Stone, Chairman and CEO

Thanks, Justine, and thanks, everyone, for joining. Our results for the first quarter are $1.33 billion and adjusted revenue, up 5.5% and $1.10 in adjusted diluted earnings per share, down 11%. Adjusted consolidated EBITDA was $464.3 million for the quarter, and our EBITDA margin was 35.4%. Continued elevated labor prices, higher-than-expected interest rates, FX headwinds and a weaker economic backdrop put pressure on our results versus our expectations. Our first quarter adjusted organic revenue was up 2.2%. Our Alternatives, Intralinks and Advent businesses continued to be the growth leaders. Excluding the impact of our healthcare business, our Q2 '22 organic growth in Financial Services, about 94% of our revenue, was up 4.4%. SS&C generated net cash from operating activities of $446.5 million for the 6 months ended June 30. We were restricted from buying back stock in Q2 '22 due to some M&A discussions, which have ended, and we paid down $234.7 million in debt. Our consolidated net leverage ratio now stands at 3.45, and our net secured leverage ratio was 2.48x consolidated EBITDA, and our goal is to reduce leverage to 3 or less. Overall, our business is experiencing more headwinds than we initially expected, especially compared to '21. We believe there are 3 main challenges affecting our revenue growth: the weakness in the healthcare business, while somewhat expected as we invest in DomaniRx, which will continue to be a 100 to 200 basis point headwind to total company organic growth; we have a lot of faith in Domani and what it can deliver in 2023 and beyond, and development is currently on target for broad-scale release on January 1, 2024; second, the full M&A market is affecting Intralinks by about $20 million from our original plan. They are still growing close to 15% and still have excellent margins. Despite the dip in deal activity, total deal value, Intralinks continues to gain market share and expects to continue to grow at about the 15% level. Lastly, the Financial Services business has taken the brunt of the FX impact. As many of you know, the dollar has been unprecedentedly strong, and we expect an additional $28 million in FX headwinds in the second half. On the expense side, our labor costs remain elevated, but there are signs of this plateauing. We communicated bonuses in the second round of merit increases in March and April, which have curbed some of the attrition, along with our employee focus initiatives, which we have highlighted in our slide deck. We will be tightly controlling our costs for the remainder of the year. Real estate reductions, IT spending, and implementing Blue Prism's digital workers throughout our operations will drive our margins back up to historical levels exiting the year. I’ll now turn it over to Rahul to discuss the quarter in more detail.

Rahul Kanwar, President and COO

Thanks, Bill. Our business remains resilient in the face of macroeconomic challenges that manifested in Q2. As you noted, Bill, foreign exchange headwinds impacted our international business, with the largest impact to our European agency and wealth revenue streams. Intralinks is also seeing some muting in the demand environment due to a reduction in M&A volumes, but grew 14.2% in Q2. The Alternatives business demonstrated our long-standing thesis that diversification among fund types, asset classes and our commercial models gives us a strong hedge against market pressures. The Alternatives business grew nicely despite some impact to new fund launches and fund inflows. GoCentral continues to roll out new functionality, enabling more efficiencies in daily processing and NABs and providing an important market differentiator in our sales process. We now have 69 clients on GoCentral in production, totaling 1,500 funds with an approximate AUM of over $300 billion. Our Financial Markets business had a strong quarter in the wake of market volatility and are well positioned to take advantage of shifting investment strategies given the breadth of our product offering. DomaniRx joint venture also continues to make progress. The new cloud-based system can now successfully execute a financial cycle, and we have completed the initial build and configuration of the API gateway and developer portal. We have accelerated our go-to-market plans, and DomaniRx can now be delivered in a modular fashion, sold as individual products, including finance, drug management, and a communications hub for existing SS&C health clients and prospects starting in Q4 2022. SS&C private markets grew 15% in the second quarter despite a slowdown in fundraising following several years of elevated activity. Prospects and clients in private markets are more than ever looking to partner with key service providers that can drive efficiencies utilizing technology, expertise, and data. Private credit and hybrid funds are a particularly attractive subsegment. We continue to innovate in this space, incorporating Geneva and other leading technologies and have multiple large private credit deals in the pipeline.

Patrick Pedonti, CFO

Thank you. Results for the second quarter were GAAP revenues of $1,328.7 billion, GAAP net income of $110.6 million, and diluted earnings per share of $0.42. Adjusted revenues were $1,330 million, including the impact of the adoption of revenue standard 606 and for acquired deferred revenue adjustments for the acquisition. Adjusted net income was $289.6 million. Adjusted revenue was up 5.5%. Adjusted operating income decreased 8.2% and adjusted diluted EPS was $1.10, an 11.3% decrease over Q2 2021. Adjusted revenue increased $69 million or 5.5% in Q2. Our acquisitions contributed $65.6 million. Foreign exchange had an unfavorable impact of $24 million or 1.9% in the quarter. Adjusted organic revenue increased on a constant currency basis by 2.2%. We had strength across several product lines, including Alternatives, Intralinks, Ads, and the Advent businesses. Adjusted operating income for the second quarter was $455.3 million, a decrease of $40.5 million or 8.2% in the second quarter of 2021. Adjusted operating margins were 34.2% in the second quarter of '22 compared to 39.3% in the second quarter of 2021. Expenses increased 8.1% on a constant currency basis. Acquisitions added $67.8 million in expenses, and foreign currency decreased costs by $20.6 million. Our cost structure was impacted by wage inflation, high recruiting costs, and higher staff to support our businesses. Net interest expense for the second quarter was $67.7 million and includes $3.9 million of noncash amortized financing costs and OID. The average rate in the quarter, including the senior notes, was 3.45% compared to 3.02% in the second quarter of 2021. We recorded a GAAP tax provision of $45.2 million or 29.1% of pretax income. Adjusted net income, as defined in Note 4 in the earnings release, was $289.6 million and adjusted EPS was $1.10. The effective tax rate used for adjusted net income was 26%. Diluted shares decreased to 263.9 million from 267.6 million in Q1. The impact of option exercises was offset by the decrease in the average share price during the quarter. On our balance sheet and cash flow, we ended the second quarter with $438.3 million of cash and cash equivalents and $7.4 million of gross debt. Net debt, as defined in our credit agreement, which excludes cash and cash equivalents of $148.3 million held by DomaniRx, was $7.1 billion as of June 30. Operating cash flow in the 6 months ended June 30 was $447.5 million, a $114.8 million decrease compared to the same period in 2021. During the 3 months ended June 30, we paid down $234.7 million of debt. Operating cash flows were down as a result of several factors, including payment of transaction expenses associated with the Blue Prism acquisition of approximately $67 million, which includes amounts paid by Blue Prism in the post-acquisition period compared to our operating activities last year. Overall, for acquisitions year-to-date, we’ve paid $1.597 billion, that includes Blue Prism, Hubwise, O’Shares, and MineralWare, and that number is net of cash acquired. Treasury stock buybacks were $170.9 million for the purchase of 2.3 million shares in the 6 months. We did not buy any shares in the second quarter of 2022. In the 6 months, we’ve declared and paid $102.4 million of common stock to add as compared to $82.1 million last year, an increase of 24.6%. Total interest paid in the quarter was $112.6 million, and that compares to $97.8 million in 2021. In the 6 months this year, we’ve paid $156.5 million of income taxes compared to $144.2 million in the same period last year. Our accounts receivable DSO ticked up a little in the quarter, up to 55.9 days compared to 52.7 days as of March 2022. Capital expenditures and capitalized software totaled $85.9 million or 3.3% of adjusted revenue. Spending was predominantly for capitalized software and IT infrastructure. In our LTM consolidated EBITDA used for covenant compliance was $2.456 billion as of June. Based on a net debt of $7.1 million, our total leverage ratio was 3.45x and secured leverage 2.48x as of June 30. On the outlook for the remainder of the year, a couple of assumptions: We have assumed that foreign currency exchange will be at current levels for the remainder of the year; we’ve assumed average interest rates will increase 100 basis points in the third quarter and an additional 50 basis points in the fourth quarter. We expect to reduce our cost structure through staff reductions, productivity improvement, facility reduction, and controlling variable expenses to improve our operating margins. We’ll continue to invest in our business in the long term with capital expenditures and capital software of approximately 3.4%. On cash flow, we will focus on improving our working capital requirements to generate cash. In addition, we are recapitalizing one of our real estate joint ventures to generate approximately $70 million of cash distribution. I would also assume we’ll continue to allocate free cash flow to both debt and stock buyback, and we’ll use a tax rate of 26% on an adjusted basis. For the third quarter of 2022, we expect revenues in the range of $1.324 billion to $1.364 billion. That will result in adjusted organic growth in the range of 1.6% to 4.8%. Adjusted net income is expected in the range of $302 million to $318 million, with diluted shares in the range of 263.2 million to 262.7 million. For the full year of 2022, we expect revenue in the range of $5.320 billion to $5.406 billion, adjusted organic growth in the range of 0.6% to 4.8%, adjusted net income in the range of $1.256 billion to $1.297 billion, and diluted shares in the range of 264.6 million to 263.6 million. On operating cash flow for the full year, we expect it to be in the range of $1.180 billion to $1.220 billion. I’ll turn it over to Bill for final comments. Thank you.

Bill Stone, Chairman and CEO

Thanks, Patrick. We appreciate your continued interest in SS&C, and we believe we’re on the right track to deliver stronger revenue growth and a more digitized workforce, which will result in a lower expense base. Our Deliver Conference is the first week in October, and we hope to see you in Orlando. I’ll now open it up to questions.

Operator, Operator

Your first question comes from the line of Alex Kramm with UBS Financial.

Alex Kramm, Analyst

There was a comment in the deck, I think, around stepping up conversations on pricing with your clients. So just hoping that you can flesh this out a little bit more. And in particular, maybe remind us what you thought at the beginning of the year, pricing could add and how maybe those fresh discussions could change that number? And then most importantly, is that already reflected in your updated organic growth guide? Or could that be incremental to what you just laid out?

Bill Stone, Chairman and CEO

Well, I think, Alex, that we have incorporated some price increases into our guidance, and we are implementing as we speak and we have implemented. I think we have adjusted based on CPI for most of our license maintenance, and obviously, CPI is quite a bit higher than it was over the last few years. Additionally, we’ve had individual businesses raising prices throughout. Rahul might have a few numbers on that.

Rahul Kanwar, President and COO

Yes. I think where we have adjusted based on CPI, obviously, we’re in the range of CPI plus 3, CPI plus 4 and some of those numbers look like anywhere between 7% and 10%. We're also going back to customers, as we’ve talked about with price increases, where contracts are renewing or where just in the context of the inflationary environment it makes sense. In general, I would say we’re targeting 5 to 7% or higher percentage increases. This is an ongoing conversation, and in some cases, we’ll end up a little better and in some cases, we’ll end up a little bit worse. As Bill noted, some of that has already been reflected in the future forecast.

Alex Kramm, Analyst

Okay. Fair enough. And then maybe just a quick one. You mentioned no buybacks this quarter because of M&A discussions. Maybe anything to flesh out there in general? What kind of areas you’ve been looking at? And then just to clarify, was that to buy something? Or are you actually looking to divest some businesses, if you can be that specific?

Bill Stone, Chairman and CEO

Yes. Well, we don’t really comment on what we’re buying or selling, Alex. But we review our portfolio all the time. We’re interested in bolstering our private markets business. We’re excited about some of the new stuff we’re doing in TAC, and we continue to look at unique asset classes that we think our clients may be moving more strongly into. Thus, we have a variety of different conversations ongoing at any one time. We thought there was a good chance that something would happen, and that’s why we felt like we had material nonpublic information, so we didn’t trade our stock. But those conversations have ended, and I would guess that we will be active in Q3 in stock buybacks.

Alex Kramm, Analyst

Sounds good. Just thought I’d check if there was more to disclose.

Operator, Operator

Your next question is from the line of Peter Heckmann with D.A. Davidson.

Peter Heckmann, Analyst

Bill, can you comment on what you think is the bottom in terms of year-over-year growth in health care? Are we seeing it this quarter? Are the client losses fully reflected?

Bill Stone, Chairman and CEO

Well, I think that as we start showing some of the modules of DomaniRx, we will start getting a reversal of trend. That’s why we have such a strong focus on that. For healthcare to be down the 24% it was, we had some more attrition than we didn’t expect. However, it’s about 6% of our revenue. While we don’t like reductions in revenue in any area, we’re optimistic that we’re investing a lot of money, and there's significant interest in that healthcare business since we acquired DST. Thus, we have a lot of options regarding healthcare. To date, we have felt like owning it is certainly better than divesting it.

Peter Heckmann, Analyst

Got it. If we thought about the healthcare business without the attrition, can you give us an idea of how revenue would look based on the underlying metrics? Is attrition the main issue here? Or is there also an issue around the number of prescriptions processed or claims or covered lives?

Bill Stone, Chairman and CEO

Yes. I think the biggest driver is the number of claims we adjudicate and pay. That’s been the most significant driver on revenue. We’ve been up close to $500 million range, and now we’re probably down in the $380 million to $390 million range. However, with Domani, we expect a large uptick in that. As always, there's a lot of regulation of PBMs and fees they charge; different states have various rules, and we’re constantly monitoring that to comply with new regulations, which tend not to enhance revenue.

Operator, Operator

Your next question comes from the line of Andrew Schmidt with Citi.

Andrew Schmidt, Analyst

I wanted to dig in a little bit on the DST Financial Services. If you could talk a little more in-depth about what drove the step down in organic growth in the second quarter. Based on implementation and sales pipeline, how are you thinking about growth in this business in the back half and next year?

Bill Stone, Chairman and CEO

We have very robust pipelines and a reasonably strong backlog of projects that we’re implementing now, which should give us some lift. The challenges are that these are very large organizations, and implementations can sometimes stretch out. However, they are still our customers, and we support them throughout this process. Sometimes, revenue recognition gets delayed. We believe that deploying digital workers throughout our business will help in our sales pipeline development as well as reduce the rate of personnel increases. We've identified several hundred FTEs that these digital workers can replace, meaning instead of hiring another 350 staff, we can deploy digital workers to meet those needs. These tasks include reconciliations, break resolutions, and compliance with Blue Sky laws. We are very optimistic about our margin rebounding back to historical levels. Despite FX headwinds and increased labor costs, we still operate at a 35% margin. Our business remains strong, and over the next quarters, we expect it to deliver even more value.

Andrew Schmidt, Analyst

Got it. I appreciate the detailed response. Last quarter, the retention issues impacted implementation. I recall it was starting to smooth out, but if you could provide an update regarding the stability of the workforce and implementation timelines across the business, that would be helpful.

Bill Stone, Chairman and CEO

It’s not as severe as it was towards the end of the first quarter and the start of the second quarter. While there are still slowdowns in major companies in their hiring and cutbacks, those can give potential employees pause. People like working for us because we are profitable and recognize that our biggest asset is our people. We’ve implemented several initiatives, which you can see in our deck. We're optimistic about the impact of Blue Prism for our operations. SS&C is making substantial investments in this business because we believe that our key services and processes will always be in demand. We expect to end this year with about $5.3 billion or better in revenue, and there's significant potential for growth. We're focused deliberately on maintaining our workforce and aiming to enhance customer service.

Operator, Operator

Your next question comes from the line of Patrick O'Shaughnessy with Raymond James.

Patrick O'Shaughnessy, Analyst

Your presentation notes that you’re committed to reducing your debt in a rising interest rate environment. However, you've also indicated that you're looking to be active in the share repurchase market. How do you balance those priorities right now?

Bill Stone, Chairman and CEO

Carefully. We’ll consider our cash generation level. My guess is that we’ll probably aim for about a 50-50 balance between debt reduction and stock buybacks, although that could fluctuate by 15%.

Patrick O'Shaughnessy, Analyst

Got it. That’s helpful. Patrick, do you have a general rule of thumb for how much a change in FX would impact the company’s EBITDA or EPS?

Patrick Pedonti, CFO

In the second quarter, the EPS impact was probably somewhere around $0.01 to $0.015 negative. Based on present exchange rates, it would likely be similar in the third and fourth quarters.

Operator, Operator

Your next question comes from the line of James Faucette with Morgan Stanley.

Unidentified Analyst, Analyst

It’s Michael on for James. I just wanted to touch on the hedge fund backdrop quickly. Obviously, we’ve seen the number of launches slowing, but you’ve also seen the size of those launches decrease. How are you performing in the blue-chip launches? What’s your share capture, and how are you thinking about hedge funds in this environment?

Bill Stone, Chairman and CEO

Do you want to take that, Rahul?

Rahul Kanwar, President and COO

Sure. During periods of market volatility and stress, we tend to perform well regarding market share in fund administration, hedge funds, and private equity. While there are fewer new launches and they aren’t as large, our revenue capture primarily comes from new clients, conversions, and market share gains, rather than new launches. The process is going well, and we are capturing our share of available opportunities in the marketplace, which should strengthen further. If things turn around, that could be quite positive for us.

Unidentified Analyst, Analyst

Great. I saw on the deck that you're also considering headcount in Blue Prism. Can you comment on the nature of those potential reductions?

Bill Stone, Chairman and CEO

We typically don’t cut sales personnel. These reductions are mostly on the support side; as we integrate these companies, we’re eliminating duplicative functions in legal, finance, IT, and other areas. However, we're excited about the potential that Blue Prism brings.

Operator, Operator

Your next question comes from the line of Chris Donat with Piper Sandler.

Chris Donat, Analyst

Bill, I wanted to ask another question regarding the price increases you’re implementing. Can you provide some insight into client receptivity? Given market conditions, they may have minimal appetite for price hikes, yet they recognize the inflation implications. How have they reacted?

Bill Stone, Chairman and CEO

You’ve characterized it accurately. No one likes price increases, but they also want their teams compensated accordingly. The industry is populated by significant players, and we’re not in a position to demand extreme hikes. Our clients understand that these adjustments are necessary to combat inflation impacting our business. They recognize this is part of a natural cycle.

Chris Donat, Analyst

For my follow-up, I wanted to connect some aspects regarding cost controls and your real estate footprint. You’ve implemented HR initiatives with hybrid work, and it sounds like attrition may be plateauing. Are these related issues?

Bill Stone, Chairman and CEO

Yes, they are related. If people don’t come into the office— and they don't— we don't need the real estate space we currently have. We are transitioning to a hoteling model versus dedicated offices. This change has altered our operational setup, and we’re trying to be flexible while maintaining customer service and meeting growth targets.

Operator, Operator

Your next question comes from the line of Kevin McVeigh with Credit Suisse.

Kevin McVeigh, Analyst

Is there any way to assess the impact of cost controls on your revised guidance? Has that been fully integrated?

Patrick Pedonti, CFO

For Q2, we anticipate about $50 million in cost reductions in the back half of the year. About $25 million of this has already been completed. The remainder is primarily due to ongoing reductions in facilities while improving productivity with the Blue Prism product and curtailing discretionary spending.

Kevin McVeigh, Analyst

Thank you. It appears the revenue retention and AUA remained stable despite market volatility. Is there anything notable to mention?

Bill Stone, Chairman and CEO

What Rahul mentioned earlier is relevant; during tumultuous times, clients prioritize quality. We expect that to positively influence our business moving forward as it has in the past.

Operator, Operator

Your next question comes from the line of Jeff Schmitt with William Blair.

Jeff Schmitt, Analyst

On Blue Prism, it seems to be doing better than you expected. Do you have any updates on the revenue growth and EBITDA margin projections for that company?

Bill Stone, Chairman and CEO

In the second quarter, Blue Prism grew approximately 17%, which was slightly better than we expected. They incurred a couple of million dollars in operating losses. We anticipate they will move to profitability in the second half of this year and likely end the year around 10% margins. For next year, we expect about 25% margins and aiming for 40% in 2024, which align with our corporate averages. We’re confident in the benefits it will bring to our overall business.

Jeff Schmitt, Analyst

That’s helpful. Regarding the healthcare business, are the client losses primarily in the medical claims area rather than pharmacy claims? I’m trying to gauge the margin difference between the two.

Bill Stone, Chairman and CEO

Yes. The overall business remains profitable, but we've experienced attrition in our client base and workforce. We aim to maintain profitability despite challenges. The DomaniRx initiative represents a significant investment for us. Based on our market assessments, there is currently no direct competitor for DomaniRx, which gives us optimism.

Operator, Operator

There are no further questions at this time. I will now turn the call back over to Mr. Bill Stone.

Bill Stone, Chairman and CEO

Again, we appreciate all of the interest that all of you show. We hope to improve upon our results. We've encountered a lot of headwinds in the second quarter, yet we still reported approximately 35% EBITDA margins. We look forward to talking to you at the end of October, and we hope to see all of you in Orlando. Thanks again. Goodbye.

Operator, Operator

Ladies and gentlemen, thank you for participating. This concludes today’s conference call. You may now disconnect.