CDK Global, Inc. (CDK) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CDK Global Q2 FY15 year earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

I would now like to introduce your host for today's conference call, Ms. Elena Rosellen, Senior Vice President of Investor Relations.

Thank you, I'm here today with Steve Anenen, CDK's President and Chief Executive Officer; and Al Nietzel, CDK's Chief Financial Officer. Thank you for joining us for our second-quarter FY15 earnings call and webcast. Steve will begin the call with the highlights for the quarter and an update from our recent Board meeting. Al will then take you through the details of the quarterly results and discuss our forecast for FY15.

We also noted in this morning's press release that we will be posting financial schedules to our Investor Relations website updated for the second quarter of FY15. This information now includes EBITDA for both the quarter and the full-year forecast. That, along with the KPIs that were included in the press release, should help with your models.

Additionally a reconciliation of GAAP to non-GAAP financial measures is included in this morning's press release and is available on the Investor Relations section of our website. And finally, we anticipate filing our Form 10-Q later today.

Before we get started I would like to remind everyone that remarks made during this conference call will contain forward-looking statements. These statements involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements, including those risks detailed in our filings with the SEC. With that I'll now turn the call over to Steve.

Thank you, Elena. Good morning to everyone and thank you for joining us for our earnings call. Let's just jump right in.

Our revenue for the quarter grew 7% and was in line with our expectations. However, we exceeded our expectations with adjusted pretax earnings growth of 35% and over 300 basis points of both adjusted pretax and EBITDA margin expansion, resulting in a 23.2% EBITDA margin. Al will give you more color on our financial performance, but before that I would like to give you an update on just a few items.

With regards to the overall industry, the US auto market is entering its sixth consecutive year of growth, with the SAAR on its way to 17 million new car sales for the first time since 2001. Throughout the industry both OEMs and dealers are healthy and looking to spend on growth initiatives. Dealers are refurbishing their stores, building new ones, and both OEMs and dealers are making technology investments for the future.

Buy-sell activity is up, economic indicators remain strong, and fundamentals are good. Outside of the US, markets are mixed but steady. Our strong market position allows us to benefit from all of these positive trends.

OEM's and dealer's willingness to invest in technology was apparent at this year's National Auto Dealer Expo show. We just got back from the show and I'd like to share with you a few observations.

As you may have seen in our press release, we introduced over 140 meaningful innovations highlighting our quicker development process as a result of our adoption of the agile methodology two years ago. A key focus of ours is to drive new and innovative solutions, to optimize workflow, improve the customer experience and enhance dealer profitability. We experienced strong booth traffic; we are quite pleased with the positive feedback from both clients and prospects who viewed our demos.

New sales leads were up nicely from last year's NADA, so I would say our solutions are resonating with dealers and hitting the mark. Elena and I were also glad to see many of you, our investors, at the show. We appreciate how respectful you were of our time, understanding that our main focus was on our clients and prospects. We will assure you that we will have demos of our solutions at our spring Analyst Day for you to view and ask further questions.

I'd also like to share with you that just before the NADA show we had our second Board meeting. We did it in Seattle. As a result of the meeting we were pleased to announce an initial share repurchase authorization for up to 10 million shares of our common stock, which, in addition to our regularly quarterly dividend, is the next step in our return of capital plan. We also recognize that we have excess cash on our balance sheet and we are considering additional ways to deploy that capital.

And finally, I want to update you on an important initiative that we have undertaken. As discussed with many of you, now that we are an independent company, we are undertaking a comprehensive effort to review our cost structures to see how we can enhance margins while protecting and sustaining our business. On our last call, we stated that with solid revenue growth in the mid- to high-single digit range, our current business model supports margin expansion of 50 to 100 basis points per year.

That being said, we are engaging an outside consulting organization to work with us in analyzing all aspects of our business to understand how and where we can meaningfully improve upon what we already have in place. We have recently initiated this review and plan on sharing our initial focus and framework with you when we host you at our spring Analyst Day. I want to impress upon you that this is a priority for us as an organization and that we have the full support of our Board.

With that, I will now turn it over to Al to take you through all results for the quarter and then our full-year forecast. Al?

Thanks so much, Steve, and good morning, everyone. Before I get to the results I want to point out that in this morning's press release and in our slide presentation we have shown both GAAP results as well as the adjusted results for the quarter in order to present both periods on a comparable basis. My comments for the quarter, as well as the full-year forecast, will largely be on this as adjusted non-GAAP basis.

Also, as I mentioned on last quarter's call, FY15 is a transition year for CDK due to all the ins and outs needed to make things comparable on a year-over-year basis. We have included multiple tables in our press release and on our websites which provide transparency to these items.

Now let's move to the results for the quarter. Total revenue growth was a solid 7%, all organic. However, due to the strong dollar, revenue growth was negatively impacted by roughly 1.5 points from unfavorable foreign exchange rates in the quarter compared with the year ago.

And as we covered last quarter, framing our discussion on revenue are the KPIs we provide in the earnings release which are also defined in our quarterly SEC filings. I'd simply reiterate these KPIs are not intended to explain total revenue growth within the segments but rather they explained the recurring or subscription-based components of our revenue, which is about 60% to 65% of total revenue.

Automotive Retail, both North America and International, contributed a combined 5 points. And Digital contributed 3 points of overall revenue growth for the quarter. ARNA's revenue growth of 7% was driven by increased DMS site penetration of 5% and an increase in average revenue per DMS client site of 4%. Our Core DMS solution, along with Networking and Telephony were strong contributors; followed by our Lot Management and ServiceEdge solutions.

ARI's revenue growth of 3% resulted from increased revenue per DMS client site. However, client counts within ARI declined 1% as the economic landscape in Continental Europe is still somewhat challenging, but the environments within the UK and China continue to be quite positive. The 17% growth of our Digital Marketing segment was driven by strong growth in OEM advertising spend, which contributed over half of the growth.

Now I'd like to move to cost. We continue to estimate an incremental $40 million to $50 million for stand-alone costs on an annual basis. For FY15 we continue to anticipate about $33 million with the full-year impact taking place in FY16.

These incremental costs were about $8.1 million in the second quarter, with $3 million of systems and software related reported within the ARNA segment and SG&A on the P&L. And there is $5.1 million within the Other in our segment reporting and also within SG&A on the P&L. These are clearly presented in the supplementary schedules included in this morning's press release.

Looking now at the P&L, cost of revenues increased 10% primarily due to the $15.6 million of accelerated amortization for the Cobalt trade name we are no longer using. Excluding these amounts, cost of revenues increased 4% from a year ago, primarily due to increased ad placement costs on higher volumes in our Digital Marketing business.

Cost of revenue also includes R&D, which represents about 8% of overall revenues. SG&A increased 2% including the $5.1 million of public company costs I just mentioned, partially offset by the true-up of a vacation accrual that I will discuss shortly.

Moving on from cost, adjusted earnings before income taxes grew 35%, negatively impacted by about 2 percentage points from unfavorable FX. Adjusted pretax margins expanded 370 basis points to 18.1% and adjusted EBITDA margin expanded 350 basis point to 23.2%. Adjusted net earnings was up 36% and diluted earnings per share increased 37%. So, solid results for the quarter.

Before I move on, I wanted to explain that these results included a $6.4 million favorable item. We recorded a true-up of our employee vacation accrual, which is a calendar year benefit, as a result of our separation from ADP. This accrual adjustment contributed 9 points of adjusted pretax and net-earnings growth, 125 basis points of margin expansion, and over $0.02 in the quarter.

I'm mentioning this as its contribution to our results will not recur, but will turn around as the calendar year 2015 vacation accrual builds in our fiscal third quarter.

Now let's move to the forecast. As we look at our full-year forecast, the year-over-year comparisons are again on an as-adjusted basis. Due to the unfavorable foreign exchange environment, we now anticipate revenue growth of 6% to 7% from the $1.97 billion in FY14.

However, given the strength of our second quarter and our first six months results, we are now increasing our earnings and margin forecasts. We now anticipate 13% to14% growth in adjusted earnings before income taxes from the adjusted $303.7 million in 2014. This translates into 100 basis points of adjusted pretax margin expansion from 2014, resulting in adjusted earnings before income tax margin of about 16.4%.

We also expect about 100 basis point increase in adjusted EBITDA margins from 2014, resulting in an adjusted EBITDA margin of about 21.2%. We anticipate 9% to 10% growth in adjusted net earnings from the $205.9 million in FY14. And finally, adjusted diluted earnings per share, we expect 8% to 9% growth from the adjusted $1.28 we had in FY14.

I want to pause on that for just one moment. When we reported back in November, the adjusted EPS for 2014 for comparability to this fiscal year was $1.29 a share. This changed to $1.28 due to the increase in stock comp expense in FY15 as a result of the increase in share price. The current expense estimate is used to adjust FY14 to be comparable to 2015. The impact was actually a half a penny, but the rounding resulted in the change you see here.

Share buybacks beyond what is needed to offset anticipated dilution from employee equity compensation plans is not considered in our forecast for EPS. This forecast suggests that the earnings and margin expansion will not be as strong for the remainder of the year. Let me explain why.

As I mentioned on our last earnings call, there are a couple of significant items that will create challenges in the year-over-year comparisons as we move through our second half of our fiscal year. First, there was a $6 million nonrecurring benefit related to an acquisition adjustment and last year's third quarter.

Next, we had a favorable mix of upgrade installations in last year's fourth quarter which benefited the margin, as it did in this year's first quarter by about $5 million to $6 million. Finally, the $6.4 million benefit from the true up of excess vacation accrual will not recur but will turn around, as the calendar year 2015 accrual builds in the second half of our year. To sum it up, these three items represent approximately $18 million of pretax earnings pressure in the second half of the year.

One last item, I want to remind you that the favorable effective tax rate in the first half of this year is anticipated to turn around and become unfavorable for the remainder of the FY15, and result in a higher adjusted ETR of 34.5% to 35% compared to the 32.2% in FY14.

With that I will turn it back to the operator and Steve and I will be happy to answer any questions you have.

(Operator Instructions)

Our first question comes from Ian Zaffino with Oppenheimer.

As you look at the share buyback, I know you talked about buying back shares above and beyond the dilution. How aggressive are you going to be? What is the timing of that and how should we sort of think about that?

I think, as was in the press release, we do intend to buy back shares as we talked about to offset the dilution of the equity programs. We will be working with the Board as it relates to the buybacks as we enter the second half of the year. As you can see from the balance sheet, we have $400 million on the balance sheet, so we plan to really opportunistically buy shares back depending on a variety of factors including: M&A activity, our share price and market conditions. And that's really all I would read into it right now.

Okay. And then on the margin expansion, you are now talking about 100 basis points of margin expansion. Is there something you sort of saw in the Core business that kind of led you to the 100 basis point now discussion?

Did it have to do with any of your discussions with the consultants, or are the consultants above and beyond that 100? And then, as it relates to the consultants, is the whole study and everything going to be complete by the Investor Day or is it going to take longer? Just give us a little bit more detail on that, thanks.

I think what I would say is the moving of the margins from the 50 to the 100 is really just, again as I said, the strength of the first six months of the year. It really isn't related to the program that Steve discussed earlier in terms of initiating the cost studies and so forth.

Let me jump in on that. We just are evaluating a number of firms, so we are in the first stage of the evaluation. You probably know most of them, typical names.

With that, we've looked at the business and said it's a traditional model, 50 to 100 basis points. This year, the year is building rather nicely and I think we are comfortable in close to 100 basis points.

That being said, under Board direction and the like, we're saying what other things should we look at foundationally in the business that we can address so that over a longer horizon we can expand those margins at a greater pace? And with it we will go through the selection process. We'll then frame out areas we want to analyze, and we'll look at almost every area of the business, both individual marketing space in the core business as well as the international business, in order to try to build a model that can build better margin expansion going forward.

That's about it for right now. But hopefully after the selection process and we have framed it out, when you come to the Analyst Day we can spend time giving you a little bit better color around what we are going to frame out.

Okay, great. Thank you. That's a very good quarter and glad to hear all the initiatives you have in place. I think this is really going to work out. Thanks.

The next question comes from Gary Prestopino from Barrington Research.

A couple of questions. Steve, you mentioned new innovations at NADA. Could you maybe talk about some of the ones that were really catching the dealers' attention?

There was actually a number of them. I can just give you an example.

As we did some of the road shows we talked about a couple of these, but Real Traction, for example in the entire back-end service lane where we've, if you will, tried to use mobility and iPads and the like to be able to not only handle what consumers we have from an appointment setting, but also the lane write up, all the way through inspection. We've partnered, if you will, with Ford. They were in our booth; we were in theirs talking about the new innovation of the way we work off the back-end. I think that was pretty meaningful.

Secondly was an area around the whole digital marketing space. We've built a solution set now that kind of handles like an audience of one. It kind of works with consumers as they work their way through the Internet and we can personalize the message for them.

It was very much like when you shop on Amazon and you are able to constantly have content information that's served up to you that is a lot more meaningful for your buying decision, and that's exactly what we do with this solution set. That was pretty important.

We also showed a lot of our early build around our front office solution. It's actually up in pilot. We will talk to you a little bit more about that at the Analyst Day, but a lot of good feedback on that early throes of our ability to rewrite a lot of our front-end office solution in order to try to drive more transactions up earlier into the Internet. So that's a big piece.

We showed our IP Telephony solution, which now we've added a feature which is really the ability from your workstation to actually text in a mobile fashion back to consumers. That was well perceived.

Lastly, the whole area around cash management where we automated from purchase orders, to payables, to automatic updates of the general ledger, to right into generating the check through payables, all automated in a very efficient manner and I think that worked out extremely well. My thought is to take and package up probably the better ones and to try to have those at the Analyst Day so you guys can get a real good sense of how that's helping to change the way that dealers are interacting with their consumers.

Okay, then you talked about the outlook in terms of dealer spend and it looks pretty rosy for this year. Were there any concerns that the dealers bought up in terms of what they are seeing in the industry?

I didn't and I talked to a number of dealers. I think there was a little bit of euphoria because of the new car sales; I think the health of their businesses. Clearly, when you think about just the macroeconomics out there, employment gains are better, lower gas prices. Consumer confidence is rising. Credit availability is still there. They are seeing rebates and the like come back.

I would say that, if anything, a lot of them are looking at their franchises and there's a lot of activity out there for buy-sells. And many of them, especially the more progressives, are saying how do I expand my footprint and leverage my business and get more scale out of it by buying opportunities that might be presented? I think the concern, if anything, is there is so much technology now being thrown at them that they are looking at it and saying help me figure this out.

I know the consumers are looking to have information more transparent. I know the consumers are looking to say they want an easier experience. Help me, as my provider, navigate the way that I can get the most impact for my business with consumers, but also help me become more effective and efficient so I can drive better profitability going forward. And we are navigating that with them.

I don't think as much as concern, as much as real excitement, and I think that was demonstrated throughout the entire show.

One last question. On the international side, Al, you mentioned there was some erosion in the dealer base. Is that just because of the economic conditions there? Were there closures or were those deconversions?

The concentration of a lot of that was in southern Europe in particular, and it really was a little bit out of businesses and so forth. It wasn't on the competitive side. It was more on the Auto business side of it.

I think the strength we have demonstrated, both in the UK and in Asia-Pac within China, it has done well and in South Africa as well. That is, again, to me a testament to the model that we've got where, despite some challenging headwinds that you still see in Europe, we are able to navigate that fairly well.

Thank you.

(Operator Instructions)

Our next question comes from [Brian Bissett] from Morgan Stanley.

Good morning and thank you for taking the question. I was wondering if maybe you could just dig in a little bit on the review that you're planning on engaging a third-party in the business. And in that sense, maybe if you could enlighten us into the conversation that you had with the Board. You know, the Company's been around for quite a while but it was tucked inside ADP.

Is there any initial expectations of how they view the business; how it might be run or analyzed differently now that you're outside of ADP? Initial expectations for what might be looked at in basically the change in the management of the Company, at least from a corporate structure perspective, and how that might affect how you look at the business and analyze the cost structure.

Brian, this is Steve. A couple things. First off, I think the Board, as well as the Chair, would say that the business is in a good position relative to its overall market presence. I think they like the leadership position that we have.

I think we've demonstrated over the last 10 years we can grow this business at a pretty significant clip. I think our outlook has always been in that 6%, 7%, 8% range without acquisitions. I think if you look at the fundamentals relative to how we've gone to market, we've looked at things in order to gain market share and be able to sell additional layered applications into that share, and hold onto clients for a long lifecycle, on average probably 20 years with 90% plus retention rates.

So, the fundamentals of a recurring revenue business, along with that I think the Board would say good, solid business with leadership position and, if anything, look at the ways you invest for innovation because that's going to be the changing game going forward. What are we doing in order to make sure we can structure our business in a way to get the best yield out of every area in the business where we can build better product that hit the mark. And if we can't build it in a timely enough fashion, then what would we do with the cash that we generate in order to look at potential acquisition targets as a good use of cash in order to drive overall shareholder value.

All those fundamentals are there. What we have done with the Board is we said, listen, now is a perfect time for us; we are out 120 days. Let's look at all of our margins and see if there are areas we could get a lot more effective. So, leaning a process out from early days of design to where it might be today, leveraging technology that was not available perhaps in the past, using our capital appropriately for that technology I think is important.

Looking at our facility footprints. Are we optimized around facilities? And if we are not what should we do? And if there are ways we can improve our procurement we should look at that in a more strained eye to say that there's areas in that area that we can improve.

How effective are we relative to service or implementation and are we leveraging all the technologies available? And, quite frankly, are there things, given the position we might have from a pricing standpoint, that we ought to look at a pace that we can drive more pricing power or, for that matter, be able to build a business that says on a sustainable way we can take advantage of some of the uniquenesses we bring. All of those things are up for review and we're going to take it in a mindful manner. We are using an outside firm to help us.

And were those things that were not addressed as you were inside ADP, or are these things that are incrementally directed towards how you are going to grow the business? In other words, did ADP kind of take a step back and say you are growing at the average rate, at corporate average margins and we are happy with that and focus on other areas? How did they view the business when it was tucked inside that company?

I've been with ADP a long time. ADP does a real good job of trying to look at ways to maximize margins, but you do it on a cadence that perhaps isn't at a pace that we are going to try to accelerate. And because we are independent we can do some things if we have to restructure and the like. Perhaps that wasn't top of the list under the ADP umbrella, but it might be on ours.

And so we're going to take advantage of, if you will, a fresh look at all areas and I think that's healthy for the business. Under ADP, good kinds, good direction, but a cadence that perhaps wasn't as accelerated as what we're going to try to do for this business.

Maybe if I could just tuck in one housekeeping one. Constant currency revenue guidance, what would that have been if the FX wasn't a factor?

It's about a 1.5, as I said in the release Brian, so figure about 150 bps.

Thank you.

Do we have another caller?

Our next question comes from Stephen Davis with JPMorgan.

It's Stephanie. Congratulations on the results.

Thank you.

The new margin expansion guide of 100 basis points implies a pretty significant step down in the second half. How much of that would be from tough comps or mix versus conservatism?

I think, Stephanie, and we did it in the remarks, we have about $18 million of second-half challenges. I talked about the vacation accrual that we mentioned. The mix upgrade we have with the upgrades that we enjoyed in last year's fourth quarter.

And the third one that's fairly significant is the earnout adjustment that we had on an acquisition from last year as well. Those three clearly create some headwinds for us as we enter the second half of the year.

All right. Now to follow-up on margins, your incremental margin growth has jumped around a bit in the past few quarters. I know there has been a bunch of puts and takes, but can you talk to what a normalized growth level would look like?

As we talked about the model -- and I actually think it is very consistent what Steve has talked about. As we look at the business model, being able to sustain the 100 basis points of margin expansion because of the inherent scale that we enjoy in the business and so forth, is very reasonable. I wouldn't categorize it as conservative.

I think what Steve mentioned early on in the call and with his other comments about the critical review that we are doing, that can change some of that. So, I think what you should be thinking about is a sustainable business model that, all things being equal, would yield that 100 type of basis margin point expansion assuming we have, call it, in the 7% range of revenue growth.

Again, as you think about the portfolio and your conversant in it, with the digital asset that grows at an accelerated rate with the lower margin profile and the Core business growing at the 5% to 6% range that has a much higher profile. So, that headwind creates some normal challenge. But we think, again, with the strength of the business model and the scale that we do enjoy we can sustain the 100 basis points.

All right, one last one from me on margins. Slower International growth has given you guys a bit of an opportunity on the margin side in that segment. Could you talk a bit to what initiatives you have taken to expand margins in the region; how much runway you have for out-years?

I think what's happened in the international arena over the last few years with some changes that Steve put in place, is the team has been very focused on doing what I would categorize as less things a lot better than more things not as good. It's not like they weren't good because they are, but the focus that the team has had on it has been exceptional really.

What I would also say, when you're in the number of countries that we are in, the margin profile is just different because some of the infrastructure needed to support languages and so forth. So, they have enjoyed some scale and I believe will continue to do so, but again what I would just caution on is I don't see it getting to the exact point that we enjoy here in the North America ARNA market. But I think we're going to see steady progress out of International, as we expect out of all of our business units.

Would you ever consider exiting some of the lower margin countries?

We look at the portfolio and, as part of the review that we are undertaking, we are looking at everything. I never like to say never, but that is part of what we owe to our Board and others to say let's take a look at it. And we do this.

Stephanie, Steve. That's a difficult one only because, as you know, internationally you work sometimes in a framework agreement with a manufacturer and they don't want you just to be in selected countries. They prefer, if they are going to work with a provider, to be able to work across their network and so we try to do that as best as we can for most of them.

I think we evaluate it and where it makes sense we would, but if it doesn't and the network play is pretty large, we will go wherever they need us to go. That being said, we just launched our new Autoline Drive product internationally and it's gaining a lot of traction. You probably saw the press release on Toyota in the UK. They are going to do the entire network of all Toyota dealers there under that solution set, as are others.

And so as we get that traction going with the new application, you will see the training curve of all our associates have to come up and so there's a little bit of a drag there. But once that happens I think we will hit full speed. A lot of opportunity, I still think, in the international space, although Western Europe has still got its problems.

All right. Thank you, guys. Congratulations again.

I'm not showing any further questions at this time. I'd like to turn the call back over to Steve for closing remarks.

Let me just summarize it very quickly. We are four months into our independence. Our Board has met twice and they are guiding us to more quickly kind of assess ways to create long-term value for all the shareholders.

As a result, we in management are accelerating the assessment of our business model, as I highlighted earlier. We, and the entire management team, are committed to embracing all the opportunities to operate more efficiently while also protecting the business and strengthening our lead. We look forward to our work over the next several months and our update to all the shareholders at our next spring Analyst Day. Thank you very much for listening.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.