CDK Global, Inc.
Q3 2015 Earnings Call Transcript

Published: 30 Apr 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the CDK Global Third Quarter 2015 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, Senior Vice President, Investor Relations. Please go ahead, ma’am.

[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 third quarter fiscal 2015 earnings call and webcast. Steve will begin the call with the highlights for the quarter and provide some comments on the comprehensive review of our business that we kicked off during the third quarter. 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 third quarter of fiscal 2015. That along with the KPIs that were included in the press release should help with your models. Additionally, the results reflect revisions with respect to hardware lease accounting and the non-controlling interest in CVR, our computerized vehicle registration business. These revisions impact the ARNA and ARI segments. 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 quarter in order to present both periods on a comparable basis. 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 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 details in our filings with the SEC. With that, I’ll now turn the call over to Steve.

[Steve Anenen:]

Thank Elena. Good morning and thank you for joining us for our third quarter earnings call. Let me start by saying I’m pleased with our results. We are now seven months into being a public company and our field organization continues to execute well. Total revenue grew 5%, 7.5% on a constant currency basis. Adjusted pretax earnings grew 16%, and adjusted pretax margin increased 170 basis points. Adjusted EBITDA margins increased 140 basis points to 23.4% for the quarter. Al will give you more color on our financial performance, but before that, I would like to provide you with some comments on the business optimization undertaking we announced last quarter. As discussed on our last earnings call we have begun the major comprehensive review of our cost structure with the goal of expanding margins while protecting and sustaining both our business and our market leading position. The consulting organization we’ve chosen has been actively engaged in working with us in analyzing our business with a fresh set of eyes. We are two months in to the diagnostic phase and we’ve selected a number of key focus areas that we will provide the most opportunity for expanding our margins. We have assigned executive ownership, are in the process of organizing teams, and sequencing the work streams for each of those focused areas. We will share the results of this review at our June Investor Day and we will provide our execution roadmap and financial goals for both revenue growth and margin expansion, based on the work that has been done. I want to impress upon you that this is a top priority for us as an organization and requires thoughtful execution while we continue to deliver against the expectations of our clients. With that, I will now turn it over to Al to take you through our results for the quarter and then our full year forecast.

[Al Nietzel:]

Thanks Steve and good morning everybody. As we have said before fiscal 2015 is a transition year for us due to all the pro forma adjustments needed to make things comparable on a year-over-year basis. You will again see that we have included multiple tables in our press release and on our website which provide transparency to these items. You will also see we have adjusted last year’s third quarter and the full year 2014 for two additional items that are significantly impacting the year-over-year comparability of our results. These are not new items, we told you about them in each of the last two quarters. One is a $5.6 million favorable acquisition related item and the other is a $7.2 million income tax benefit. We have talked about them, but we understand some of the modeling challenges so we have shown them in our pro forma schedule. Keeping that in mind, my comments for the quarter as well as the full year forecast will largely be on this as adjusted non-GAAP basis. Now, let’s move to results for the quarter. As Steve mentioned total revenue growth was 5% all organic or 7.5% growth on a constant currency basis. CDK’s FX exposure is primarily to the euro, Canadian dollar and pound sterling. And as we covered last quarter, framing our discussion on revenues are the KPIs related to recurring or subscription based revenues that we provide in the earning release which are also defined in our quarterly SEC filings. For ARNA revenue growth of 8% was driven primarily by increased DMS site penetration and an increase in average revenue per DMS client site. Our core DMS solution along with networking and telephony were strong contributors to the growth. We are pleased with the revenue growth, but want to point out the quarter benefited from a higher mix of nonrecurring items so we do not anticipate growth of 8% next quarter and it is not a new run rate. For ARI revenue growth of 3% resulted from increased revenue per DMS client site primarily from additional users. Site counts within ARI continued to be down year-over-year due to the still somewhat challenging economic landscape in continental Europe. However the environment within the UK and Asia-Pac continue to be positive. For digit marketing revenues grew 11%, which was lower than the first half of the year. OEM advertising spend significantly increased during last year’s third quarter and we don’t fully lap that level of higher spend until the fourth quarter. You have heard me say this before but it is worth repeating that revenues from digital advertising campaigns are more one-time in nature and can create uneven quarterly growth rates. We anticipate an even greater quarter challenge in the fourth quarter. We are however pleased that 8 points of the digital marketing growth came from website related revenues due to strong average revenue per client site which increased from a year ago. Growing these revenues is a key focus area for us and it is the higher margin component of our digital business as compared to OEM revenues. Now I would like to move to cost. We have narrowed our estimate for standalone costs to about $45 million to $50 million on an annualized basis. For fiscal 2015 we anticipate about $30 million with the full year impact taking place next year in fiscal 2016. These incremental costs were about $9.6 million in the third quarter and they are presented in the supplementary schedules included in this morning’s press release. Looking now at the costs at the P&L rather, cost of revenue on a reported basis increased 6% from a year ago primarily due to increase additional placement to support growth in our digital marketing business and increase cost associated with the migration of hosting facilities that support ARNA and digital marking segments. Cost of revenues includes R&D which represents about 8% of total revenues. SG&A on an as reported basis increases 10% primarily due to the $9.6 million of public company costs I just mentioned. Moving on from costs, adjusted earnings before income taxes grew 16%, negatively impacted about two percentage points from unfavorable foreign exchange. Adjusted pretax margins expanded 170 basis points to 17.4%, and I’m pleased with the margin improvement in both ARNA and digital marketing. Adjusted EBITDA margin expand 140 basis points to 23.4%, and you’ll see we revisited our adjusted EBITDA calculation and now add back total stock comp expense which is consistent with the approach of our peers. And finally adjusted net earnings and diluted earnings per share attributable to CDK increased 16% and 13% respectfully. And during the quarter as part of our capital deployment strategy we acquired 689,000 CDK shares for $32 million. Our cash balance as of March 31 is $368.5 million down from about $400 million last year. Now I will move on to our forecast. As we look at our full year forecast, the year-over-year comparisons are again on an as adjusted basis. Our pro forma adjustments of the $5.6 million favorable acquisition related item and the $7.2 million income tax benefit in last year’s third quarter along with the revisions Elena mentioned earlier resulted in a change to our forecast ranges which I will review in a moment. For the full year, we now anticipate revenue growth of about 5% or about 7% on a constant currency basis from the $1.97 billion in fiscal year 2014. The U.S. dollar was stronger in the third quarter, and we anticipate a continued unfavorably foreign exchange impact versus a year ago. For the fourth, quarter we anticipate a 3.5% to 4% negative drag to revenue growth, and about 4% drag on pretax margins growth from unfavorable foreign exchange versus a year ago. The full year negative impact on FX is anticipated to be about 2 percentage points on both revenue and pretax earnings growth. We anticipate about 15% growth in adjusted earnings before income taxes from the adjusted $308.2 million in fiscal 2014. This translates into about 150 basis points of adjusted pretax margin expansion from 2014 versus our prior forecast of about 100 basis points. Half of the change is related to better than expected business performance and the other half is due to the change in the pro forma presentation. We also expect about 150 basis points of adjusted EBITDA margin from 2014 resulting in an adjusted EBITDA margin of 22.2%. We anticipate about 15% growth in adjusted net earnings and 14% to 15% growth in adjusted diluted earnings per share attributable to CDK. I would like to make just a couple more comments about what we anticipate in the fourth quarter. I already mentioned the expected significant FX headwind. Additionally as it relates to revenue, we anticipate a greater impact in the fourth quarter from the growth over of last year’s OEM digital advertising revenues and the downward pressure on losses due to non exclusivity with two OEM in our website business. And as a reminder, ARNA revenue growth is anticipated to be back to the range achieved in the first half of the year. Now looking at earnings, I mentioned on each of our prior calls we had a favorable mix of upgrade installations in last year’s fourth quarter which benefited the margin as it did in the first quarter of this year by about $5 million to $6 million. This, along with negative FX rates creates significant earnings growth and margin pressure on the fourth quarter. Having said all that, the outlook I provided is solid and we are tracking to achieve this full year forecast. With that, I will turn it back to the operator, and Steve and I will be happy to answer any questions you have.

[Operator:]

[Operator Instructions]. And our first question comes from Rayna Kumar from Evercore. Please go ahead.

[Unidentified Analyst:]

Hi, this is Anthony beginning on for Rayna Kumar. I was hoping you could quantify any pricing changes you made in DMS and digital marketing businesses this quarter.

[Steve Anenen:]

Pricing changes nothing at all for this quarter or even for this year.

[Unidentified Analyst:]

I guess moving on to the cost cutting initiatives. What are your largest areas for cost cutting in 2015?

[Steve Anenen:]

We’re going to cover off on all of that during the Investor Day meeting in June. Right now I’m not prepared to go through those. But we will give you a full disclosure of what the work streams are and what we’re focused on and we’ll kind of give you a preview of how it impacts for not only the near-term but also the long-term. I would rather wait until that meeting so we can be more comprehensive. I will tell you that a lot of rigor has gone into it. We have been heads down for almost two months now looking at all those work streams, and I think you’ll get a better more clear picture what it will look like going forward.

[Unidentified Analyst:]

One more, maybe could you give us what your 2015 and 2016 expectations are for the number of DMS client sites and number of websites.

[Al Nietzel:]

It is early for that. I think if you -- this is Al. If you think about what we have been communicating about where we expect our growth to come from we have tended to look at some of our growth coming from both increased client sites and the other from layered applications and so forth. At this point it is fairly consistent with what we have been communicating in terms of our previous presentations.

[Operator:]

Thank you. Our next question comes from Ian Zaffino from Oppenheimer. Please go ahead.

[Ian Zaffino:]

Hi, great. Thank you very much. Question would be over in Europe what are you basically seeing over there? I know some of the data has started to improve and to turn. What are you seeing there in particular? And then also is the amount of transactional revenues in Europe similar to the translational revenues in the U.S.? And then I have a follow-up. Thanks.

[Al Nietzel:]

I’ll hit the transaction first and then Steve will go through some of the other climate issues that we see in International. But unlike our North America business that we have a computer vehicle registration business coupled with a bureau business for Experian, Equifax, TransUnion and so forth our internationally business isn’t susceptible to any of the ups and downs in transaction at all. So there isn’t a transaction element to our nationally portfolio today.

[Steve Anenen:]

Regarding the landscape clearly still Western Europe, Southern Europe still pretty tough although I think they’re coming out of it from flat sales to I think some promising looks in a few of the countries, but clearly Spain is still pretty tough. France is tough. Germany is coming out of it a bit. We see a lot of promise and continue to see it in the U.K. some of the Middle East areas are going well. South Africa has been good for us and quite frankly Asia-Pac including China has done reasonably well. I think it is still early but the good news is I think we bottomed out and starting to see some improvements in Europe and as a result I think that bodes well for us going forward.

[Ian Zaffino:]

Thank you. And then on the guidance it seems like are all the adjustments purely FX related, is there anything else going on there? I know you said a little lumpiness in digital. But just curious about the FX just given that a lot of the FX move was really in the past quarter as opposed to now, but if you could give us any color there that would be helpful.

[Al Nietzel:]

The only thing, Ian, is the comparison versus last year is fairly acute and it did deteriorate from our third quarter to now and that continuation into the fourth quarter is a pretty big headwind. And as I said earlier we have about a 3.5% to 4% drag as compared to a year ago on the FX. And it is hurting the bottom more -- it is hurting both the top and bottom more in the fourth quarter for us than earlier in the year. Because our full year impact of FX is going to be about two percentage points in revenue and same on pretax earnings.

[Operator:]

Thank you. And our next question comes from the line of Stephanie Davis from JP Morgan. Your line is open.

[Stephanie Davis:]

Given the loss of exclusivity in certain DMS client contracts this past quarter, does it signal any change in the relationship and how would you size the timing and impact?

[Elena Rosellen:]

Stephanie, it was hard to hear you; if you wouldn’t mind repeating that?

[Stephanie Davis:]

Sure, no problem. Is this any better?

[Elena Rosellen:]

Yes.

[Stephanie Davis:]

All right, perfect. So given the loss of exclusivity in certain DMS client contracts this past quarter, does it signal any change in the relationship and how would you size the timing and impact if any?

[Steve Anenen:]

I think it is in the digital marketing area where we have lost exclusivity, so they went to open contract. They did that with VW and Hyundai did that a bit ago. It has some impact to us but we have retained I think some of the larger and greater share of the revenue particularly with VW. They opened it up to a number of providers. That being said, it will have some impact clearly in the fourth quarter but our pipelines are pretty strong both at the manufacturer area as well as with dealer groups. And I think I mentioned to most of you that we were recalibrating our go to market strategy with our digital marketing organization and focusing on calibrating the organization to look at dealer groups where our strengths is and relationships are. And I think we’ll with see some of the benefit of that coming up in the coming months. So some early signs of positive traction, the pipelines are building and stay tuned more to come.

[Al Nietzel:]

And, Stephanie, the impact to those couple of items on the fourth quarter is about a five percentage point drag in digital. So it is not an insignificant item.

[Stephanie Davis:]

Goes right to my follow-up. Could you talk a bit about the mix shift then in DMS?

[Al Nietzel:]

Shift in DMS. I’m not sure I know the question, Stephanie. Within digital we are seeing more emphasize on the digital the website and subscription based service activity and that mix has helped us in terms of the quarter, and you’ll see that in some of the margin expansion we enjoy during the quarter. On the core DMS side of the house there isn’t any mix shift that we’re seeing on the DMS side.

[Stephanie Davis:]

Last of all from me. You have talked about pursuing acquisitions as part of your cash priorities at the spend. Is there any update in the M&A pipeline or any change in strategy?

[Al Nietzel:]

Well, we talked about tuck in acquisitions and we’re very inquisitive we’re looking at a lot of different areas where we can improve our overall effectiveness with our applications. If it means buying something small that we can’t build ourselves, we’ll do that. That being said, out in California we bought a small company it is called AVRS. It is a computer vehicle registration software that we think blends well with our solution set, and California is a big market for us. And so we acquired them and we’ll move forward if you will integrating that application set into our DMS. And I think that will provide a lot more seamlessness as well as very good software into attending to those client needs in California. Other than that, no, Stephanie, it is really a focus around tuck in acquisitions and that’s where we are right now.

[Operator:]

Our next question comes from Gary Prestopino from Barrington Research. Please go ahead.

[Gary Prestopino:]

Good morning. I just wanted to touch on the digital marketing side. You mentioned a little bit about this, Steve, but some of the margin expansion that you have seen is that a really emphasis of moving from Tier 1 to Tier 3?

[Steve Anenen:]

Actually it is Gary. There is some of that going on couple with a focus too on some of the dealer group as well as the more subscription based website activities. And then we have been able to -- so we have enjoyed a favorable mix shift within the digital business coupled with some cost containment efforts that the team has put in place out there has benefited us in the quarter as well.

[Gary Prestopino:]

And then next the drop year-over-year in websites is that a function of some of that loss or loss of exclusivity business?

[Steve Anenen:]

Yes, it is Gary.

[Gary Prestopino:]

So could you give us -- on the digital marketing side could you give us an idea of where you are as a percentage on Tier 1 versus Tier 3 and where you want to be?

[Al Nietzel:]

Gary, that is not something that we would want to do right now in terms of putting that out. I think what I would say is and we have talked about this before is for our overall digital portfolio about 40% of it is on the subscription based model and about 60% is on the digital advertising side of it. And we’re working to shift that mix appropriately for the right balance. It is not 100% team left to go to nothing but websites of course, because it is a key components of our offering but it is really about the balance that we’re trying to strike.

[Steve Anenen:]

Gary, this is Steve. I would say the focus on the sales organization a little bit of a shift towards the dealer groups where our strength is with the DMS I think is beginning to show fruits of our labor, and as a result a lot of the efforts that we have done relative to building out our platform is now being able to take what we have done at the network level and actually bring it down to the dealer level. And our new packages around AMP or audience management, is really getting some good traction and I think it helps if you will integrate into the DMS so that we’re working real--time. And there are things we’ll show you at the Analyst Day around what we’re doing with the digital marketing, DMS interface that I think will be very, very beneficial.

[Gary Prestopino:]

Okay. And then last question and thank you for that, on the ARNA it looks like your average revenue per site year-over-year had a nice bump as well as sequentially. Is this really a function of more up take of some of those newer products that you guys debut at NATA?

[Al Nietzel:]

I think, Gary, again we talk about what our strategy is about it. It is capturing additional marketing share and Steve and the team and the sales organization and operations have a keen focus on trying to layer in additional services to our offering that help dealers make more money is ultimately what we’re trying to do. And I mentioned a couple of about the networking, telephony, but between the service applications as well as some of the F&I application we have been able to increase the share of wallet that we have and enjoy with dealers and that is really a continuation of the strategy.

[Gary Prestopino:]

Okay. And then just lastly as your sales force is out there talking with the dealers, what is the pulse of the market right now? I mean what are the dealers saying and what are they looking for in terms of technology?

[Steve Anenen:]

I would tell you, Gary, that there is a lot of optimism in the marketplace. There is certainly – the dealers given their index level is a lot more profitable than where they were years ago. I think they’re more inquisitive about opportunities for them to extend particularly the more larger dealer groups and you see some of that by sale activity happening. But I think they are optimistic. The SARS rate continues to improve albeit a little bit slower than what it was several years ago. But they’re still calling for north of $17 million and that’s a strong transaction volume. And that being said, I think they’re focusing their eyeballs around service and absorption rates and their ability to be able to make, if you will, the service equation pay for their dealerships. I leave it with the optimism that’s out there continues to resonate.

[Operator:]

Thank you. And our next question comes from Brian Desouza from Morgan Stanley. Please go ahead.

[Brian Desouza:]

I was wondering if you could dig in a little bit on North America retail. In terms of the revenue growth there maybe help me understand how much is land versus expand? In other words, where did some of the client site growth come from and did that then translate to a substantial contribution to revenue, or was it more along the lines of increase wallet share within existing customers?

[Al Nietzel:]

I think we covered a little bit of that. It is a combo of both. We referenced the sites in our tables so you can see where some of the growth came from in terms of how much of the revenue expansion came from actual sites, and I think we are hitting on both of those right now in terms of both client sites that are coming in to the CDK family coupled with layered app penetration. And I also mentioned we had a higher level of some onetime activity that benefited the growth in North America. So I would be thinking more of a normal rate that we see in the first half of the year versus the growth that we experienced in the third quarter. However what I will say is that the scale that we enjoy in that business is nice and you saw that and the margin expansion that the North America organization delivered. So again, it is continuation of the execution that we have been outlining for a while.

[Brian Desouza:]

Okay. And on margin expansion North America retail, if I were to look at some of the stuff I guess the breakdown by segment that you had on your website prior to call and the adjustments that you made to 1Q last year if we were to make similar -- like reverse those adjustments this quarter how comparable is that to last year? I guess trying to get into the detail in terms of when you decided to make the adjustment to the prior period and the catalyst for that?

[Al Nietzel:]

I’m not sure exactly how to answer that other than to say the third quarter is when we made the adjustments. And the third quarter adjustments one was tax and the other was for the acquisition true up with digital marketing and ARNA rather. I’m sorry, ARNA. And those are reflected. So the margin expansion you are seeing is apples to apples.

[Brian Desouza:]

I guess I’m just trying to get into based on the segment break out that you had on your website prior to this call. I mean you adjusted the first calendar quarter last year for some of those accounting adjustments with regard to hardware it looks like. And I’m just wondering what would the impact have been on this quarter make it like for like versus what you had on there before?

[Al Nietzel:]

What I would say is they’re rather de minim in terms of their impact. And we have got them as what we say is on an apples-to-apples basis and that’s the way you should think about it. And maybe what we do, Brian, is if after the call you want to get with Elena, we can go through more.

[Elena Rosellen:]

Yes.

[Brian Desouza:]

That would be great.

[Al Nietzel:]

But it is comparable; it is apples-to-apples.

[Brian Desouza:]

Finally, with regard to FX and your expectations of the quarter, I think you had a substantial move in January before you reported last quarter results, I guess -- and if that spiked a little bit in March as well. So, I just want to understand what the date you set your assumption was on the call last quarter.

[Al Nietzel:]

We used -- I think it was the mid-month April rate that we used for calculating the balance of year forecast for the impact on FX. And it’s moved on us since the last call. And that’s really the prime driver in the change in the guidance on revenue although we also are reflecting the conversation we had on digital as well.

[Brian Desouza:]

But on the last earnings call, you’d already had a big move in January; I guess when you set guidance last time, what were your assumptions on FX and understanding that it’s moved since then, so you had…

[Al Nietzel:]

The assumption we would have made the last quarter would have been on the mid month rate at the time of the call in January. The rate from January till April had moved and therefore that’s what caused the additional derogation in revenue. And as I said, it is literally -- it is 3.5% to 4% drag versus where we were last year.

[Brian Desouza:]

Sure. Okay, that is helpful. Thank you.

[Al Nietzel:]

And the full year impact is 2 points on a gross. So, we’re talking about again a fairly significant impact on us, which is very similar to what see elsewhere.

[Operator:]

Thank you. And at this time I’m showing no further questions. And would like to turn the call back to Steve Anenen for closing remarks.

[Steve Anenen:]

Great. In closing, let me just say we’re feeling pretty about our progress to date. We’ve achieved good financial results for the first nine month of fiscal year 2015. I think we’re executing against our forecast for the year. We are committed to shareholder friendly actions, which returning excess cash to shareholders. We paid two dividends and we have begun a share repurchase program. We are fully engage in our business optimization review in order to accelerate margin expansion. Myself, the entire management team is committed to embracing all opportunities to operate more efficiently while protecting and sustaining our business and our market leadership position. We look forward to seeing many of you in person as we provide an update at the Investor Day in June. And I want to just thank everyone for listening and for attending the call and I wish you a great day today. Take care.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. And you may now disconnect. Everyone have a great day.