CDK Global, Inc.
Q2 2015 Earnings Call Transcript

Published: 5 Feb 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the CDK Global Q2 Fiscal Year '15 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 like to now like to turn today's conference call to Ms. Elena Rosellen, Senior Vice President of Investor Relations. You may begin.

[Elena Rosellen:]

Thank you. I am 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 fiscal 2015 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 fiscal 2015. 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 fiscal 2015. 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 model. 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 forward in the forward-looking statements including those risks details in our filings with the SEC. With that, I'll now turn the call over to Steve.

[Steve Anenen:]

Well thank you. Elena. Well, 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 pre-tax earnings growth of 35% and over 300 basis points of both adjusted pre-tax 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 U.S. auto market is entering its sixth consecutive year of growth with this [Nissan] [ph] on its way to 70 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 OEM’s 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 U.S., markets are mixed but steady. Our strong market position allows us to benefit from all of these positive trends. OEM’s and dealers willingness to invest in technology was apparent at this year's national auto dealer expo show. We just got that from the show and I would like to share with you a few observations. As you may have seen in our press release, we introduced over a 140 meaningful innovations, highlighting our quicker development process as a result of our adoption of the actual methodology two years ago. A key focus of ours is to drive new and innovative solutions, to optimize work flow, improve the customer experience and enhance dealer profitability. We experienced strong booth traffic, we were quite pleased with the positive feedback from both clients and prospects that viewed our demos. New sales leads were up nicely from last year's NIDA. So I would say that our solutions are resonating with dealers and hitting the mark. Al and I were also glad to see many of your 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 would also like to share with you that just before the NIDA 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 regular quarterly dividend is the next step in our return of capital plan. We also recognized that we have excess cash on our balance sheet and we're considering additional ways to deploy that capital. And finally, I want to update you on our 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’ll now turn it over to Al to take you through our results for the quarter and then our full year forecast. Al?

[Al Nietzel:]

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, fiscal year '15 is a transition year for CDK due to all the in 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 through the quarter. Total revenue growth was a solid 7%, all organic. However, due to the strong dollar, revenue growth was negatively impacted by roughly a 1.5 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 filling. I’d simply reiterate that these KPIs are not intended to explain total revenue growth within the segment or rather they explain 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, contribute a combined five points and digital contributed three points of overall revenue growth for the quarter. Autos 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, telephony were strong contributors followed by our lot management and service head solutions. Retail revenue growth of 3% resulted from increased revenue per DMS client site. However, client counts within ARI declined 1%, as the economic landscape and Continental Europe is somewhat challenging, but the environments within the U.K. 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 standalone cost on an annual basis. For fiscal '15, we continue to anticipate about $33 million with the full year impact taking place in fiscal '16. These incremental costs were about $8.1 million in the second quarter with $3 million of systems and software related reported within the auto segment and SG&A on the P&L and there was $5.1 million within the other and our segment reporting and also within SG&A and 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’re no longer using. Excluding these amounts cost of revenues increased 4% from a year ago, primarily due to increased ad placement cost 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 cost I just mentioned, partially offset by the true-up of a vacation accruals that I’ll discuss shortly. Moving on from cost, adjusted earnings before income taxes grew 35%, negatively impacted by about two percentage points from unfavorable FX. Adjusted pretax margins expanded 370 basis points to 18.1% and adjusted EBITDA margin expanded 350 basis points to 23.2%, adjusted net earnings was up 36%, and diluted earnings per share was 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 nine points of adjusted pretax and net earnings growth of 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 fiscal 2014. However, given the strength of our second quarter and our first six months results, we’re now increasing our earnings and margin forecast. We now anticipate 13% to 14% growth in adjusted earnings before income taxes from the adjusted $303.7 million in fiscal 2014. This translates into a 100 basis points of adjusted pretax margin expansion from 2014 resulting in adjusted earnings before income tax margins of about 16.4%. We also expect about a 100 basis point increase in adjusted EBITDA margin from 2014resulting 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 fiscal 2014. And finally adjusted diluted earnings per share, we expect 8% to 9% growth from the adjusted $1.28 we have in fiscal 2014. 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 a $1.29 a share. This change to a $1.28 due to the increase in stock comp expense in fiscal 2015 as a result of the increase in share price. The current expense estimate is used to adjust fiscal 2014 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 suggest 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 couple of significant items that will create challenges and the year-over-year comparisons as we move through our second half of our fiscal year. First there is a $6 million non-recurring benefit related to an acquisition adjustment in last year's third quarter. Next we had a favorable mix of upgrade installation 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. And finally the $6.4 million benefit from the true-up of excess vacation accrual will not recur, but will turnaround as the calendar year 2015 accrual build 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 turnaround and become unfavorable for the remainder of the fiscal year 2015 and result in a higher adjusted ETR of 34.5 to 35, compared to the 32.2 in fiscal year 2014. With that I’ll turn it back to the operator and Steve and I will be happy to answer any questions you have.

[Operator:]

[Operator Instructions] Our first question comes from [indiscernible] with Oppenheimer.

[Unidentified Analyst:]

As you look at the share buyback, I know you talked about buying back shares above and beyond the dilution. How aggressive will you -- what sort of the timing of that and how should we sort of think about that?

[Al Nietzel:]

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 share back depending on a variety of factors including M&A activity. Our share price and market conditions and that's really all agreed in it right now.

[Unidentified Analyst:]

Okay, and then on the margin expansion you are now talking about 100 basis points of margin expansion. Is there something that you saw in the core business that that kind of led you to the 100 basis point now discussion? Did that had to do with any of your discussion of the consultants or are the consultants above and beyond that 100. And then as it relates to the consultants, it is sort of the whole study and everything going to be complete by the Investor Day or is it going to take longer and just kind of give us a little bit more detail on that? Thanks.

[Alfred Nietzel:]

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

[Steve Anenen:]

Yes, let me jump in on that. We just are evaluating a number of firms, so we're 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 inside, its traditional model 50 to 100 basis points. This year, the year is building rather nicely and I think we are comfortable and 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 will then frame out areas that we want to analyze and we'll look at almost every area of the business both individual marketing space in their core business as well as the international business in order to try to build the model that can build better margin expansion going forward. And that’s about it for right now, but hopefully after the selection process and we framed it out when you come to the Analyst Day we can spend time kind of give me a little bit better color around what we're going to frame out.

[Unidentified Analyst:]

Okay, great, great. Thank you, that’s very good quarter and glad to hear all the imitative you have in place. So I think this is really going to work out. Thanks.

[Steve Anenen:]

Great.

[Operator:]

Our next question comes from Gary Prestopino with Barrington Research.

[Gary Prestopino:]

Couple of questions, Steve you mentioned the new innovation at NATA. Could you may be talk about some of the ones that were really catching the dealers attention?

[Steve Anenen:]

Yes, there was actually a number of them. I’ll just give 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 line where we if you will try to use mobility and iPad and the like to be able to not only handle what consumers we have from an appointment setting, but also the lane right up all the way through inspection we partnered we partnered if you will before. They are in our booth. We are in theirs talking about the new innovation of the way that we work off the backend I think that was pretty meaningful. Secondly, was an area really 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're able to if you will constantly have content information that served up to you that’s a lot more meaningful for your buying decision and that's exactly what we do with this solution that was pretty important. We also showed a lot of our early build around our fun 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 throws of digital rewrite a lot of our front end office solution in order to try to drive if you will 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 work station actually text in a mobile fashion back to consumers that was well proceed. And lastly a whole area around cash management where we automated from purchase orders, to payables, to automatic updates of the journal ledger, to right into generating the check through payables, all automated in a very efficient matter and I think that worked out extremely well. So a lot of those and my thought is to take and package up probably the better ones and 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.

[Gary Prestopino:]

Okay. And then you talked about the outlook in terms of dealers 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?

[Steve Anenen:]

Well I didn't and I talk 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. You're seeing rebates and the light come back. I would say that if anything, a lot of them are looking at their franchises and there is a lot of activity out there for buy-sell 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. And so I think the concern if anything is there are so much technology now being thrown at them they're 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 that 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. So I don’t think there is much concern as much as real excitement than I think that was demonstrated throughout the entire show.

[Gary Prestopino:]

Okay. And then 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 de-conversions.

[Al Nietzel:]

Mean the concentration of a lot of that was in Southern Europe in particularly and it really was a little bit auto businesses and so forth. It wasn’t on the competitive side. It was more on the auto business side of it but again, I think the strength that we demonstrated both in U.K. and in Asia pack within China has done well and South Africa as well. So that’s again to me a testament to the model that we have got despite some challenging headwinds that you still see in Europe and we're able to navigate that fairly well.

[Gary Prestopino:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Brian Desouza with Morgan Stanley.

[Brian Desouza:]

Hi, good morning and thank you for taking the question. This morning if you may be -- if you just dig in a little bit on the review that you're pointing on engaging a third party and in the business and in that sense may be if you can enlighten us into the conversation that you have with the Board and the company has been around for a quite while, but it was tucked inside ADP. Is there any initial expectations of how they view the business and how it might be run or analyze differently now that you are outside of ADP. Initial expectations for what might be looked at and basically the change in the management of the company at least from a corporate structure perspective and how they might affect how you look at the business and analyze the cost structure?

[Steve Anenen:]

Hi. Brandon this is Steve. Well couple of 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 have demonstrated over the last 10 years that we can grow this business in a pretty significant clip. I think groundwork 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 on to clients for a long life cycle on average probably 20 years with 90% plus retention rate. And so the fundamentals of 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 changing game going forward. And so what are we doing in order to make sure that we can structure our business in way to get the best yield out of every area in business where we can build better product that hit the mark. And if we can't built in a timely enough fashion then what 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. So all those fundamentals are there and so what we've done with the Board is as we said listen, now is the perfect time for us. We're on a 120 days. Let's look at all of our margins and see if there are areas that we could get a lot more effective. So leading 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 footprint. So are we optimized around facilities and if we're not, what should we do. And if there are ways that we can improve our procurement, we should look at that in a more strained eye to say that there are 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 that we might have from a pricing standpoint that we ought to look at the pace that we can drive more pricing power or for that matter, be able to build the business that says on a sustainable way, we can take advantages some of the uniqueness that we bring. So all of those things are up for review and we're going to take it in a mindful manner. We're using an outside firm to help us.

[Brian Desouza:]

And where those things that were not addressed as you are inside ADP or are these things that are incrementally directed towards how you're going to grow the business. In other words did ADP kind of take a step back and say well you may be growing at average rate a cooperate average margin and we're happy with that and focus on other areas or how do they view the business when it was inside that company.

[Steve Anenen:]

I've been with ADP a long time. ADP does a real good job of trying to look at ways to maximize margin but to do it on a cadence that perhaps isn’t at a pace that we're going to try to accelerate and because we're independent, we can do some things that we have to restructure and the like perhaps that wasn’t on top of the list under ADP umbrella. But it might in 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. So under ADP, good times, good direction, but a cadence that perhaps wasn’t as accelerated as what we're going to try to do for this business.

[Brian Desouza:]

Okay. And may be if you could just tuck in one housekeeping one and constant currency revenue guide what would that have been if FX wasn’t a factor?

[Steve Anenen:]

It's about a 1.5 as I said in the release Brian. So figure about 150 bips yes.

[Brian Desouza:]

Got it. Thank you.

[Elena Rosellen:]

Do we have another caller?

[Operator:]

One moment. I am sorry. My headset was muted. I apologize. Our next question comes from Steven Davis with JPMorgan.

[Elena Rosellen:]

Stephanie.

[Steve Anenen:]

Hi Stephanie.

[Stephanie Davis:]

Okay guys. Congratulations on the results for the quarter. And my new.

[Steve Anenen:]

Thank you much.

[Stephanie Davis:]

The new margin expansion guide of 100 basis points provide a pretty significant step down in second half how much of that would be from tough comps or mixed versus conservatism.

[Steve Anenen:]

I think Stephanie, and we did it in the remarks is we have about $18 million of second half challenges, I talked about the vacation accrual we mentioned, the mixed upgrade that we have with the upgrades that we enjoyed in last year's fourth quarter and the third one that’s really significant as the accrual and the earn-out adjustment that we had on acquisition from last year as well. So those three clearly create some headwinds for us as we enter the second half of the year.

[Stephanie Davis:]

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

[Al Nietzel:]

As we talked about the model and I actually think it's Stephanie 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. And 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're doing, that can change some of that. So I think what you should be thinking about is sustainable business model that all things being equal would yield that 100 type of basis point margin expansion assuming we have call it in the 7% range of revenue growth. And again as you think about the portfolio and your conversant in it with the digital asset that grows in an accelerated rate with a lower margin profile in the core business growing at call it 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.

[Stephanie Davis:]

All right. One last one from me on margins. Lower 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've taken to expand margins in the region and how much of runway you have for all years?

[Al Nietzel:]

I think what and 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 and it's not like they work good because they are, but the focus that the team has had on it has been exceptional really. What I would also say that when you are 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 auto market, but I think we're going to see steady progress out of international as we expect out of all our business units.

[Stephanie Davis:]

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

[Al Nietzel:]

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

[Steve Anenen:]

Yeah Stephanie, Steve, that's a difficult one only because as you know internationally you work sometimes in framework agreement with a manufacturer and they don’t want you to just to be in selective countries. They prefer if they're going to work with a provider to be able to work across their networks. And so we try to do that as best as we can for most of them and so 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 where ever they need us to go. That being said, we just launched our new online drive product internationally as its gaining a lot of traction. You probably saw the press release on in the U.K. We're going to do the entire network of all priority dealers there under that solution set as are others. And so as we get that traction going with the new occupation, you will see that the training curve of all our associates have to come up and so there is a little bit of drag there, but once that happens, I think we will head for speed. So lot opportunity I still think in the international space although Western Europe is still got its problems.

[Stephanie Davis:]

All right. Thank you, guys. Congratulations again.

[Al Nietzel:]

Thank you much.

[Operator:]

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

[Steve Anenen:]

Sure, let me just summarize it very quickly. We are four months into our independence and Ford has met twice and they're guiding us to more quickly kind of assess ways to create long-term value for all the shareholders. And as a result we and 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.

[Operator:]

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