CDK Global, Inc. (CDK) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CDK Global fourth-quarter FY15 earnings call.

(Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Elena Rosellen. You may begin.

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 FY15 earnings call and webcast.

Steve will begin the call with the highlights for the year, and then provide an update on the execution of our business transformation plan we laid out at our investor day last month. Al will then take you through the details of the full year and fourth-quarter results, and provide our forecast for FY16.

We also noted in this morning's press release that we will be posting financial schedules to our investor relations website updated for the fourth quarter of FY15. Additionally, we are providing P&L's for all the quarters of FY14 and FY15, reflecting the revisions with respect to hardware lease accounting and the non-controlling interest in our CVR business made in our third quarter.

I also want to point out that in this morning's press release and in our slide presentation, we have shown both the GAAP results, as well as the adjusted results for the quarters in order to present both periods on a comparable basis. Additionally, throughout today's call when Steve and Al reference financial amounts, those are as adjusted amounts.

A reconciliation of the 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-K in the next few weeks.

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. Hi, everyone, and thank you for joining us this morning.

We closed our first fiscal year as a public company, and delivered very good results. On a comparable basis with FY14, adjusted revenues grew 6%, 8% on a constant currency basis. Adjusted pre-tax earnings grew 17%, and adjusted pre-tax margin expanded 170 basis points. Adjusted EBITDA margin increased 190 basis points to 23.5% for the year. I am pleased with these results.

In a few minutes, Al will provide more details on the our financial performance for the year and the first quarter. But before he does that, I will update you on our progress as we continue to execute our business transformation plan to deliver significant earnings growth and margin expansion over the next three years.

Just last month at our investor day, we announced our plan to transform CDK through balanced organic revenue growth and significantly increased earnings. Our goals are clearly focused on management expansion, and our strategy will result in a strong financial profile. We will deliver additional EBITDA dollars of $250 million to $275 million over the next three fiscal years, and achieve a 35% EBITDA margin in FY18.

We will deliver these results by executing against two key pillars: driving operational excellence, while delivering organic revenue growth. CDK's transformation is centered on driving operational excellence, and that will be the focus of my comments to you this morning.

To remind you, driving operational excellence comprises three work streams: streamlining the organization, simplifying the business and pricing, and engaging with clients more efficiently. We are 30 days into the planning phase of these work streams, which we expect to complete over the next couple of months. We have already began the execution phase on certain work streams, but for the most part, execution will begin in this year's second and third fiscal quarters.

So, what have we accomplished in the first 30 days? We are developing detailed blueprints, road maps, and business cases in order to create detailed implementation plans, and the teams are being staffed. With respect to engaging clients for efficiently, we have began execution on optimizing our sales process.

Specifically, we have redefined the sales force roles and account coverage by merging ARNA and digital sales teams at the regional leadership levels. We have stratified account coverage to utilize inside sales and technology to service smaller accounts and to expand the account to sales ratio. This has resulted in reduced headcount, and will provide annual cost savings of at least $7 million.

We have begun to execute our strategic sourcing and procurement initiative, as well. Through this initiative, we have taken a very close and hard look at our vendor relationships, and we are actively pursuing opportunities to consolidate and, where appropriate, changes suppliers of products and services across the business. We expect our actions on this front to generate over $5 million of cost savings in FY16.

These are very good starts towards our transformation plan. Additionally, we are driving hard on consolidating operations, including implementation of a [hub and spoke] model for consolidating our facility footprint, and better scale our labor base in lower-cost geographies, where appropriate, both here and abroad. We are not ready to disclose the details, but we are well underway on this most critical work stream.

In terms of R&D optimization, we are currently focused on the core dealer management system, and efforts to ensure our clients are using our latest technology solutions. We are creating the inventory for DMS migration opportunities and developing migration paths for a pilot program that will ultimately allow us to sunset legacy solutions.

In terms of pricing simplification, we are identifying areas for increasing discipline around discounting and price bands, and tools to ensure compliance. We are also working towards simplifying our contracting process and reducing complexities in how we engage with client and prospects.

Keep in mind, there are interdependencies with other work streams, which makes it difficult at this time to provide further details. We have baked in just north of $45 million of additional EBITDA dollars in FY16 from these work streams.

I'm pleased with our progress thus far. We are taking significant strides towards delivering against our increased EBITDA goals, and strengthening the business while improving our client experience.

With that, I will now turn it over to Al to take you through our results for the year and for the fourth quarter, and then our FY16 forecast.

Thanks, Steve, and good morning, everyone.

CDK posted very good results for FY15. As you have heard me say each quarter, this was a transition year for CDK, and we have shown numerous pro forma adjustments in order to make things comparable on a year-over-year basis with 2014.

We've also established our standalone public company accounting and reporting processes over the last nine months. In doing so, we have made some minor adjustments in how we report certain items after our separation, versus how these items were addressed on the historical carve-out basis. None of these adjustments were material, but we deem them to be appropriate for the presentation of our financials.

Keeping that in mind, my comments for the FY15 results, as well as for our FY16 forecast, will largely be on these, as adjusted, non-GAAP basis.

Now let's move to the results for the full year 2015. As Steve mentioned, total revenue growth was 6%, nearly all organic, or 8% on a constant currency basis. Our (technical difficulties) exposure is to the euro, Canadian dollar, and pound sterling, and as we've covered previously, framing my comments on revenues are the KPIs related to recurring revenues that we provide in the earnings release, which are also defined in our SEC filings.

The ARNA segment revenues grew a strong 8%, led by both increased site penetration for our dealer management solution, or DMS, of 4%, and an increase in the average revenue per DMS client site of 3%. For RE, revenue growth of 2% resulted from increased revenues per DMS client side, primarily from additional users per client. Site counts in RE were down slightly on a year-over-year basis, due to the somewhat challenging economic landscape, primarily in Southern Europe. This was partially offset by performance within the UK and Asia-PAC. For our digital segment, revenues grew 11%, driven primarily by higher revenue per website and increased advertising spend.

Moving from revenues down to cost, standalone public company costs were in line with our expectations, and totaled $30 million for FY15. These costs are predominantly recorded within SG&A on the P&L. $22 million of the $30 million is reported within the other segment, and the other $8 million is reported within ARNA, primarily related to hosting.

Looking at P&L, our cost of revenues, on an as-reported basis, increased 6% from a year ago, primarily due to increased cost for ad placement to support growth in our digital marketing business, and increased cost associated with the migration of hosting facilities that support both ARNA and the digital segments. Cost of revenues includes R&D, which continued to represent about 8% percent of revenues. SG&A, on an as-reported basis, increased 5%, entirely due to the standalone public company costs I just mentioned.

You also saw in our release restructuring expenses of $2.4 million for FY15. This represents employee-related cost incurred in connection with our business transmission plan. This, and other fourth quarter costs of $1.9 million for consulting and other fees associated with the transformation program, are shown as pro forma adjustments on our non-GAAP tables. We will be tracking and reporting these costs to you each quarter.

Moving on from costs, adjusted net earnings before income taxes grew nicely at 17%. And was negatively impacted by about two percentage points from the unfavorable exchange rates. Adjusted pre-tax margins expanded 170 basis points for the year, totaling 17.5%, with all business segments contributing to this margin improvement.

ARNA 's pre-tax margin advanced to 150 basis points to 30%, RE's margin expanded 110 basis points to 15%, and digital's margin expanded 300 basis points to 10% for the year. Adjusted EBITDA margin expand 190 basis points for the year to 23.5%.

And finally, growth in adjusted net earnings and adjusted diluted earnings per share attributable to CDK was strong at 16% and 15%, respectively. Our cash balance at June 30 was a little over $408 million, and we repurchased 1.1 million shares during the year for $51 million. And our operating cash flow was $268 million for the year. Overall, very good results for the fiscal year.

With that, I will now touch on the fourth-quarter results, which are essentially in-line with our expectations. Total year-over-year revenue growth for the fourth quarter was 2%, or 5% on a constant currency basis. The April acquisition within our computer vehicle registration business, which is reported within the ARNA segment, contributed one point of growth for the quarter to the total business.

The ARNA segment have a strong quarter, with 8% revenue growth, 6% organic, driven primarily by increased DMS site penetration and an increase in the average revenue per DMS client site. RE revenues grew the quarter from increased users per site, but this was partially offset by one-time revenue reductions.

Digital marketing revenues declined 2% for the fourth quarter. As we discussed last quarter, we expected year-over-year growth challenges in the fourth quarter. This was due to the strength in last year's fourth quarter from an increase in OEM budgets for advertising spend, and the anticipated decline in the number of client websites resulting from changes to certain OEM programs with respect to exclusivity.

We also spoke last quarter about the anticipated pressure on the year-over-year comps for earnings and margin growth in the fourth quarter, as a direct result of the favorable items in last year's fourth quarter. As such, adjusted earnings before income taxes for the fourth quarter declined 5%, and was negatively impacted about three percentage points from unfavorable foreign exchange rates.

Adjusted pre-tax margins declined 110 basis points to 14.6%, again due to these favorable items it last year's fourth quarter that did not recur this year. And, adjusted net earnings and diluted earnings per share attributable to CDK both declined 10%. So, while the favorable items in last year's fourth quarter created significant year-over-year pressures, the underlying businesses is performing well, as evidenced by our strong full-year results.

Looking now at our forecast for 2016, the year-over-year comparisons are again on an as adjusted basis. The schedules in our earnings release and on our website provide detail to the as-adjusted items. You will see that the earnings components for our fiscal year forecast are off a revised base of 2015.

This is important to recognize and understand. The pro forma schedules we have shown all year were developed to present 2015 and 2014 on a comparable basis. Now that we are in FY16, we have revised the pro forma adjustment schedules for FY15 to be comparable to FY16.

Clearly, my preference would be not to do these pro formas, but they are the most effective way for us to present both periods on a comparable basis. And the primary add-on items in the pro forma schedules are essentially stand-alone public company costs and interest expense.

Back to the forecast for 2016. We anticipate growth in adjusted revenues of 4% to 5%, from the adjusted $2.017 billion in FY15. This includes a 1 to 2 point drag from foreign-exchange rates, which we expect to occur in the first half of the fiscal year. We anticipate at least 25% growth in adjusted earnings before income taxes from the adjusted $330.5 million in 2015.

We anticipate at least 300 basis points of expansion in both adjusted pre-tax and adjusted EBITDA margin, from 16.4% and 22.9%, respectively, in 2015. As Steve mentioned earlier, this forecast includes about $45 million of incremental EBITDA from our transformation plan.

Also, in conjunction with the transmission plan, we expect to incur $60 million to $65 million of restructuring and other charges during FY16. About $10 million will be incurred in the first half of the year, with the remainder in the second half of the year. These charges will be presented on a non-GAAP basis, and are not included in our earnings forecast.

The effective tax rate for FY16 is anticipated to be 35.5% to 36%, compared with the adjusted 34.6% in FY15. The FY16 adjusted effective tax rate is in line with the normalized ETR we have previously communicated.

We also anticipate over 25% growth in adjusted net earnings from the adjusted $208.2 million in FY15. And we anticipate over 25% growth in adjusted diluted earnings per share attributable to CDK from $1.29 in FY15. No further share repo's are assumed in the recast beyond what is needed to buy-back shares to off-set dilution from employee equity programs, and we continue to evaluate our return of capital strategy to provide the greatest long-term value to our shareholders.

Next, I'd like to provide some directional comments regarding the quarterly skewing. I already mentioned the expected FX headwinds of 1 to 2 points for the full year. This is skewed to the first half of the year based on current rates, with the first and second quarters being impacted by 3% and two percentage points, respectfully, for both adjusted revenues and adjusted pre-tax earnings.

We had a favorable mix of upgrade installations in last year's first quarter, which benefited ARNA by about $5 million. This is expected to create pressure in the year-over-year comps for the first quarter in FY16. We also continue to expect pressure in digital marketing revenues for the first half of the year, due to the lower website counts.

Considering the negative impact from all of these items, unfavorable foreign-exchange, unfavorable upgrade mix, and pressure from lower websites, we anticipate revenue growth in the first half of FY16 will be below the low end of the full year forecast range of 4% to 5%. These items also anticipate to negatively impact pretax earnings.

In addition, net earnings growth in the first quarter of FY16 will be negatively impacted by a higher effective tax rate of 35.5% to 36%, compared with a lower 31.3% in the first quarter FY15. As a result, we anticipate net earnings growth of 6% to 9% in the first half of the year.

To grow over challenges, including unfavorable FX and lower website counts lessen in the second half of the year, as the business continues to grow. The additional EBITDA dollars from our transformation plan are anticipated to be delivered primarily in the second half of the fiscal year, as the first half of the year is focused on developing and rolling out the detailed execution plans. So, considering our expectations for the first half of the fiscal year, along with the full year forecast, revenue growth, earnings growth, and margin expansion are heavily weighted to the second half of the year.

In summary, this forecast represents the first stage of delivering against our transformation plan, 4% to 5% top-line growth, over 25% earnings growth, and at least 300 basis points of margin expansion. We know we have a lot of work ahead of us, but we're also excited and believe we are on the right track. Our transformation plan is the right thing for this business, and will make us better and stronger, serving our clients and the industry.

With that, I will turn it back to the operator, and Steve and I will be happy to take your questions.

(Operator Instructions)

Ian Zaffino, Oppenheimer.

Question for you on the FX side of it. Is there anything you could do to potentially offset some of that? Is there any clauses in your contracts or any ability for you to take price in some of those markets? And then also, are those markets actually strong enough for you to actually be able to take price, if you could? Thanks.

Yes, two things, Ian. Number one is the FX exposure we have, clearly, is really just on translation is how it works for CDK. The Canadian dollar, the euro, and the pound are the ones that are most susceptible. We bill clients in local currencies. We don't do them in US denominations, generally, so we don't -- other than the normal contractual clauses we have with pricing actions and so forth, we kind of are where we are with respect to the exposures that we do have on the FX front.

Okay. And that could you just give us a comment about the markets and the strength you are seeing over there, or not seeing?

Yes. This is Steve. The markets are improving, both in Continental Europe, particularly as the second half of this last fiscal year. We have seen increased car sales and I think a resurgence of consumers back into the marketplace, buying as the marketplace gets better. UK has been strong market for us and continues to be, along with obviously the Middle East in certain areas. South Africa continues to do well, and the Asian markets have done well for us over the last year, and continue to do so. Although, obviously there is a lot of concern around the markets in China. But that being said, I'd say there is a recovery in the marketplace, and it's going pretty well.

Perfect. Thank you so much.

Gary Prestopino, Barrington Research.

Steve, just some clarification on one of the initiatives that you are going to do here to get the margin expansion. You talked about pricing discipline around discounting and simplifying contract processing. Are you -- did your guys in the field, your salespeople in the field, have a lot of leeway in discounting or setting a price that would get a deal for your company, and you are going to basically centralize that and try to keep pricing at a fixed level, where there isn't a lot of discounting out there, from the field?

I think what we're really trying to do is -- we've tied our pricing models a lot closer to margin delivered by bundle, and that was the first step. So we simplified the price book. We've bundled, if you will, in a pricing area that they will provide us, we think, a little more transparency around where the value drivers are in the solutions that we have. That being said, probably fair to say that there was a lot more capabilities of the local sales rep to discount in the past. We are going to tighten that up, and take it to a point where more centralization of what the appropriate bands are for pricing, and I think it will give us some lift. And then we are putting in the checks and balances to make sure that we hold to what we are trying to accomplish.

And I think the only other comment, Gary, would be -- as I think Steve mentioned, is that it's the narrowing of the discount bands, is what we had. There was a fairly wide range of the spread on products that we feel are tremendously valuable to the dealers. And those are the ones where we want to garner as much value as possible. So it is narrowing the bands.

Okay, and another thing that I just picked on, you said bundling, Steve. Are you going to start bundling and move from more of an a-la cart to a one price option for the layered apps that get attached to DMS, or are you still going to sell those on an a-la cart basis?

Gary, where we are at, and I think I've said it at a couple of meetings, where a lot of what we're doing is embedding work stream workflow with applications that work in concert with one another. As result of that, you move more towards a bundling with those workflows, and I think that's how we will be going to the market. So we are evaluating it, today, and as we go forward, it will be more in that ilk than a-la cart.

Okay. And if you could, just to comment on what your people are seeing out in the field, domestically? I know we had a question on Europe, but what are some key takeaways, here? Because the industry continues to do really well. Just trying to get a pulse of what the dealers are feeling out there.

Yes, I think from my conversations with those that are out on the front line, I think there's still a lot of optimism in the marketplace. I think there is dealerships that are doing well, particularly in the areas of the service end, but new-car sales are driving a lot of volume, and as a result, I think the optimism amongst our organization is there. They are looking for ways that we can add value through using our applications in order to drive better decision processes within the dealerships, and then lastly, I'd say as dealers become confident in their ability to scale operations, many of them are continuing to look for ways that they might be able to expand their enterprises through acquisitions, and I think the acquisition front is still out there, and we benefit sometimes as a result of those acquisitions.

Thank you.

Stephanie Davis, JPMorgan.

For FY16 guidance, it implies about 220 bps expansion on the prior base. Which of course, in account for the new capital structure and public company status and shift to adjust revenues, but you said 35% EBITDA margin target. It suggests a pretty significant ramp up through 2018. Could you walk us through how to think about this ramp, and any step functions to call out?

Yes, I'll start. This is Al, and I know Steve will jump in. What we are undertaking, Stephanie, what we have really tried to outline during investor day is really a transformation. And when Steve talked about the three specific work streams, with streamlining the org, simplifying pricing, and engaging our clients. Some of the things that we are undertaking are just taking time to implement because of the significance of them. Particularly, as we look at some of the more substantive programs with the workforce and so forth. So, as Steve said, we are going through major planning and execution. Some of the phases are a little further along than others. But the benefits of them are really going to start kicking in the second half of this year and beyond, and so we are acutely aware of what it means to us in terms of the cadence of the margin expansion. But we have a goal, and we are heads down, pushing toward it.

Yes, the only other comment Stephanie, I would make, is it's the [bow-wave] that you create, if you will, starting in the second half of FY16, and then it starts to accelerate as the work streams come on. And it is holistic across the entire enterprise, not only here in the states, but throughout the international business as well. So, every one of the segments is going to have meaningful margin expansion as we go out, so we are -- we set the goal at 35%. And we think we can get there, and we have got everybody heads-down, working on those work streams, to be able to kick them off at the appropriate time.

And Stephanie, just one other comment, is the viewer or the audience shouldn't expect that it is all going to happen in 2018. We have a very rigorous plan that we are outlining that will deliver meaningful results this year, as you can see by the 300 plus basis points of margin expansion, and then that second-half exit rate is going to benefit 2017 as well. So, it is not -- we know what we have ahead of us, but you don't have to wait until 2018 to see it. It is going to be coming all along the way.

Makes sense, back-end loaded, but won't just be in 2018. Shifting gears to the recent acquisition of your public competitor. Could you comment at all on what sort of initial changes you may have seen in the competitive environment?

I think it's still a bit premature to really speculate. We haven't -- it's been just a little bit too short, but we haven't really seen all that much difference in their behavior. We have competed with them in the past, and I anticipate we will watch it very closely and see if there's any change in movement. But they are a formidable competitor, and we have got great solutions that lineup very well with them, and we will continue doing what we do well and delivering value to our clients.

All right. Thank you guys. That's all I have.

Brian Essex, Morgan Stanley.

I guess I just had a question on cash flow. And as we go into next year, how you might anticipate some of the impacts on the cash flow side, particularly cash flow from operations? I think you did a pretty good job growing cash flow through a pretty substantial transition, but just wondering how that might impact cash flow, going forward?

Brian, we are expecting, again, a nice steady improvement in our cash from operations, and I think you should expect to see that going forward. In terms of some of the disclosures we just had about some of the transformation related expenses, as we think about both our cash flow as well as our commitment to bring our cash balance down to a $250 million level, we are balancing all of those levers, and as we articulated, we are committed to returning any of excess cash we have to shareholders in the form of either dividend or buybacks. And we are going to be likely stepping that up in order to get the $408 million that we are holding as a cash balance now down to the $250 million level that we've committed to. Recognizing that we know there's going to be some cash needs as it relates to some of the transformation activities, but again, I would expect -- you should expect us to see improvements -- solid improvements in cash from operations, and as we said, we are going to provide that back to the shareholders in our return capital strategy.

It seems that you've gone through a period of accelerated R&D and product development over the past couple years. Any sense of where you are on that trajectory? And is that a potential area for savings as we exit this fiscal year?

I think the real key for us there is, clearly, it is a technology play, where this marketplace as we see the blurring of the lines between the brick and mortar and the digital internet age, we've got to continually -- continue to invest in that area. Therefore, I think we are about 8% of revenues, or thereabouts, and as I think going forward, we'll continue to invest heavily, but what we are going to do is, as I tried to mention, is look at some of the older legacy applications and platforms that we might have. Ways that we can migrate our clients and sunset that and get some lift so we can reinvest dollars appropriately into the newer offerings. So that's how I would have you think about it, Brian.

Got it. That kind of dovetails into the follow on I had. Is it sunset of legacy solutions -- any sense of what the install base there looks like? How much of an opportunity that is, and how that might be perceived by customers, as you sunset those solutions and maybe incentivize them to migrate to a higher end platform?

All of it is being evaluated right now. We have opportunity in that space, primarily probably in the international front, especially in Europe. But that being said, we just launched our latest product, AutoLine Drive there, and it's got great market reception. So, we'll move that market as that market gets its legs around the European base. That being said, in North America, there are some applications and some older products that are out there that we want to make sure we've got a clear migration path, and we want to make it as easy as possible to be able to migrate them. So we have got a focused effort on it. We will do some piloting, and we'll make sure it is as easy as possible for our clientele so we'll retain as many of them as possible. But clearly, it's early in our discussions around how we're going to set that forth, but it is part of the strategy.

Any sense of -- Are these basically subscription solutions? Or are there legacy license solutions that you would migrate over, and how might that be perceived by some of the customers? Are they on premise, or maybe [fast base] -- that would be easier to migrate?

Well, I don't know if any of them are easy to migrate, Brian. But as part of the transformation plan that we have outlined, reducing the number of versions of existing platforms and solutions is a key part of our going-forward strategy to free up dollars to invest the way Steve described in some of changes emerging in the market. Also making our organization more efficient, and making the client experience better. Migrations are never easy. We've been down this path before, and it is something that we manage with a little bit of one foot on the gas pedal and one foot on the brake to make sure that we don't create too much client disruption. But we do what we can to make it as easy for them to move to our best platform and our best solution.

And streamlining the organization, Brian, will require us to try to move everybody to the most current technology, and that is to their benefit as well as to ours. And that's really what our focus is. We've moved many our them to our drive platform, already, but there still some danglers out there that we want to make sure that we treat them well, and migrate them where appropriate.

Thank you.

I would now like to turn the call back to Steve Anenen for closing remarks.

Great. Thank you. I think you can tell from our comments that we are pleased with the results in FY15. We improved our earnings and our margin outlook each quarter this year, and we delivered a very good results. We have returned $108 million to our shareholders through cash dividends totaling $58 million and $50 million for the repurchase of 1 million CDK shares. We have 8.9 million shares remaining on our current repurchase authorization, and I'm confident that we have entered FY16 from a position of strength.

We are moving forward, and our entire management team is engaged and committed to execute against our transformation plan to drive a CDK that is more efficient and easier to do business with. No doubt about it there's a lot of heavy lifting to be done, but we are up for it. And keep in mind, we will deliver significant earnings growth and margin expansion while growing the business, which is we believe the most optimal business model for delivering long-term value. It's really an exciting time to be part of CDK.

Thank you for listening today. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a wonderful day.