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Good morning, and welcome to the Clarivate Analytics Q2 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Anthony Gerstein, Vice President and Head of Investor Relations for Clarivate. Please go ahead.
Thank you, operator, and good morning, everyone. Thank you for joining us for the Clarivate Analytics Second Quarter Fiscal 2019 Earnings Conference Call. With me today are Jerre Stead, Executive Chairman and Chief Executive Officer; and Richard Hanks, Chief Financial Officer.
As a reminder, this conference call is being recorded and webcast and is copyrighted by Clarivate Analytics. Any rebroadcast of this information in whole or in part without prior written consent of Clarivate is prohibited. This morning, Clarivate issued a press release announcing its second quarter fiscal results for the period ended June 30, 2019. The release as well as an accompanying investor presentation is available in the Investor Relations section of the company's website, clarivate.com under the Events & Presentations.
During our call, we may make certain forward-looking statements within the meaning of the applicable securities laws. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the business or developments in Clarivate's industry to differ materially from the anticipated results, performance achievements or developments expressed or implied by such forward-looking statements. Information about the factors that could cause actual results to differ materially from anticipated results or performance can be found in Clarivate's filings with the SEC or on the company's website. Our discussion for the quarter will include non-GAAP measures or adjusted numbers, including adjusted revenues, adjusted subscription revenues, adjusted transaction revenues, adjusted EBITDA and free cash flow. We will also provide our required disclosure of a stand-alone adjusted EBITDA. Clarivate believes non-GAAP results are useful in order to enhance an understanding of our ongoing operating performance, but they are a supplement to and should not be considered in isolation from or as a substitute for GAAP financial measures.
After our prepared remarks, we will open up the call to your questions. With that, it's my great pleasure to turn the call over to Jerre.
Thank you, Anthony, and good morning to everyone on our call. We very much appreciate you all joining us today. It's been about 2 months since I took the CEO position. We're moving very quickly to execute on initiatives that will accelerate revenue growth and margin expansion. I've said this before, Clarivate represents a unique and powerful set of assets. Our customers cannot operate effectively or efficiently without our products and solutions. We are a trusted, independent and indispensable partner to innovators everywhere, delivering critical data, information, workflow solutions and deep domain expertise. We have numerous opportunities to invest in the right initiatives, leveraging our assets. To help us realize this, we've engaged the Boston Consulting Group to provide us with their objective evaluation of the best structure for Clarivate as a new public company. This will help us to accelerate our path to long-term sustainable profitable growth, and this quarter is the beginning of that path. I'll provide an overview of our second quarter results, share some of the progress we've made on important initiatives, and then Richard will provide more detailed financial commentary. I'm very pleased with our results for this quarter, which were in line with our expectation. Adjusted revenue increased 2.5% on a constant-currency basis, and they were driven by solid adjusted subscription revenue growth of 5%. Annual contract value of subscription-based agreements increased 3.6% with revenue renewal rates approaching 92% for the 6-month period ending June 30. While we're pleased with 92%, we will always be striving for a higher renewal rate. Adjusted EBITDA increased 8.4% to $73.2 million in the second quarter and free cash flow of $18 million for the 6 months ending June 30, was inclusive of approximately $30 million of merger-related expenses. We've also had some outstanding commercial wins, 2 of which I'll highlight. In May, we announced an exciting new distribution agreement with Standards Australia, including Australian Standards and other technical documents, further expanding Techstreet's library of industry codes and standards. In July, we expanded our strategic partnership with White Rabbit, the leading domestic provider of trademark search and watch services in China. White Rabbit is now deploying CompuMark's artificial intelligence and image recognition technology to dramatically simplify and streamline trademark image search and watch processes for Chinese trademark professionals. I want to congratulate and thank all of my colleagues for their focus and hard work in achieving these results. It's not easy to work through the noise of a major merger in addition to the completion of the separation from Thomson Reuters and I'm very, very proud of our Clarivate team and their commitment to serving customers with excellence and ensuring that we deliver against our goals.
I'd like to share with you some of the insights we've gained through our -- one of our first initiatives we undertook, a better understanding of the voice of our customers. Those of you who know me will remember how strongly I believe in the importance of understanding the viewpoint of our customers and staying current with customer feedback on our performance. Without this insight, no company can sustain long-term profitable growth and risk becoming marginalized or obsolete. One of the very first things we did after the merger closed was to bring in a world-class customer experience service company to help us understand the customer's viewpoint and to identify improvement areas. We completed our first survey with many more to come in the future, and I'd like to share some of the findings and our actions. First, our overall customer delight score was 76, which is quite strong, best-in-class is 80-plus. We have room for improvement on a good start. Second, our scores for information and insights and quality and products and services were 87% and 85%, respectively. These 2 categories measure our customers' opinions about our products and our content. These scores were very strong. To put that in perspective, I've not seen scores in those categories this high before. These were the best scoring questions. What that means is that our customers see tremendous value in our products across all of our business units. As investors in Clarivate, this is important for all of us and is a very strong attribute for our company. If we don't have content solutions to customers value, it's hard, very hard to fix that problem and grow a successful company. However, if customers value our products, other issues are much easier to fix. So these scores represent great news and a really good start for Clarivate as a new public company.
Now moving on to our third score, which assessed whether or not we are easy to do business with. It was not surprising to many of us, we scored 54%, which is one of the lower scores I've seen on this question, the best practice is well north of 60%. If we put this all together, what we've heard in our first survey is that our customers highly value our product offerings, while telling us that we are not an easy-to-do-business-with company. This insight highlights exactly what we need to do in order to improve and grow. It's about fixing processes, simplifying things and execution, all within our own control. And you can bet, we've already begin to get at this. By focusing on customer delight and executing on our other strategies, we will improve Clarivate's organic growth trajectory. We'll deliver more of the growth to the bottom line, we'll drive towards best-in-class margins and free cash flow conversion. As we've analyzed the survey results, we're developing a road map of actions we will take to address the feedback. This includes, adopting a better product and pricing enhancement strategies, by shifting from a product sales strategy to a value-based strategy, by integrating additional content and capabilities into existing products and increasing our pipeline of new products, by continuing to build strength in Asia as we capture significant opportunities in APAC, and therefore, accelerate revenue growth in that region and then in our company and by pursuing opportunities for inorganic growth and portfolio optimization. M&A is an important part of our plan. While high levels of customer delight are critical to our future, so our leading levels of colleague engagement in the establishment of a very strong corporate culture. One of my goals is to ensure that our company is recognized as a great place to work and a great place in which to invest a career.
Shortly after the close of the merger, we got right to work on putting in place the strong vision, mission and values. I'd like to share those with you today. Our vision is, we will improve the way the world creates, protects and advances innovation. Our purpose of our mission is, we believe human ingenuity can transform the world and improve our future. And, importantly, our values define the way we work with one and other in all of our constituencies. The overarching idea of our values is that we will own our actions. We will act with integrity, we will be accountable to ourselves, our colleagues, our customers and our communities. Our values are: aim for greatness; value every voice; and own our actions. I've had a long career leading companies in trying to inspire tens of thousands of colleagues. One of the things I've learned is that, without a strong culture and equally strong set of guiding principles, it's very hard to be a truly successful, long-term organization. I'm very proud of this work and think it's one of the best vision, mission and values I've been part of. I know it will serve us well as we move forward to a very successful future.
Now moving to 2019 guidance. We are reaffirming our guidance for 2019. Adjusted revenues in the range of $962 million in $995 million, adjusted EBITDA in the range of $290 million to $310 million and adjusted EBITDA margins of approximately 30%. In addition to this guidance, we have provided with you with our expectations for excess stand-alone cost and pro forma cost savings, which will help you get to our stand-alone adjusted EBITDA range, which remains unchanged guidance-wise between $325 million and $345 million. To wrap it up, it's been a couple of really busy months but much progress made so far. I'm very proud, as I said, of the team who have stayed focused on serving our customers with excellence and delivering on our commitments and goals. I'm confident that by continuing to focus, simplify and execute, we will deliver on our stated goals for years to come.
Before I turn the call over to Richard, I want to share with you that our company will hold our first-ever Investor Day in New York, on Tuesday, November 12. This will include presentations from our commercial leadership team, and we will also feature product demonstrations that you can see how our products and solutions are used by our customers. We very much look forward to seeing you there and continuing to update you on our progress.
I'll now turn it over to Richard to discuss the financial results before we open up for your questions.
Thank you, Jerre. As mentioned, our results for the second quarter were in line with our expectations. Reported revenues decreased by $1 million or 0.4% to $242.3 million in the second quarter of 2019 from $243.3 million in the prior year quarter. Recall, the prior year revenue includes the results of IPM of $5.8 million, which accounts the decline. IPM was sold in the fourth quarter of 2018. Adjusted revenues increased by $4 million or 1.7% to $242.4 million in the second quarter of 2019 from $238.4 million in last year's second quarter. As a reminder, this excludes revenue from IPM from prior quarter as well as the impact of purchase price accounting deferred revenue adjustments. Foreign exchange was approximately $2 million of headwind in this year's quarter, mainly arising from euro and sterling weakness. On a constant currency basis, adjusted revenues increased by 2.5% in the second quarter compared to the second quarter of 2018. Please note that approximately 83% of our revenues in the second quarter of 2019 were U.S. dollar-denominated. When looking at revenue by geography, we have a nice balance of revenue across the regions, with 46% of our revenues from North America, 25% from Europe, 22% from APAC and 7% from emerging markets. This geographical mix is similar year-on-year.
Moving on to revenue by type. Adjusted subscription revenues adjusted for sale of IPM grew $9.6 million or approximately 5% at constant currency for the quarter. We realized subscription growth across our product lines in both our Science and IP groups. The large dollar increase in the quarter was within the Web of Science product line. The increase in subscription revenues is driven in part from the effect of price increases as well as new business. Adjusted subscription revenue accounted for 84% of total adjusted revenues in the quarter compared to 82% in the prior year period. This reflects our ongoing strategy of growing our recurring subscription revenue base.
At the end of the second quarter, the annual contract value, or ACV, of subscription-based contracts increased 3.6% at constant currency compared to the same period last year. This should lead to further improvements in subscription revenue growth in subsequent quarters. As a Jerre mentioned, retention rates were approximately 92% for each of the 6-month periods ended June 30, 2019 and June 30, 2018. Adjusted transactional revenues, which represent approximately 16% of total revenues in this year's second quarter, declined $4.1 million or 9.4% to $39.7 million. This is down 8.4% on a constant-currency basis.
The decline in transaction revenues is partly the results of both timing, as transactional revenues vary more by quarter and are generally more difficult to predict and, secondly, our strategic initiatives as we continue to shift more product offerings to customers under subscription agreements rather than transactional agreements, particularly in the IP Product Group. Our fourth quarter is traditionally the strongest for reporting transactional revenues.
Looking now at the performance by product group. Adjusted Science group revenues grew $3.6 million or 2.7% to $136.1 million from $132.5 million in the prior year, up 3.3% on a constant-currency basis. The increase in a Science group revenues were driven by subscription revenue growth, offset by lower transactional revenues. Science group accounted for a 56% of total adjusted revenue, which again is consistent with the prior-year period. The Web of Science product line continues to achieve very strong renewal rates. Adjusted Intellectual Property group revenues increased slightly to $106.3 million and by 1.5% on a constant-currency basis. Intellectual Property group revenues were driven by subscription revenue growth offset by the aforementioned lower transactional revenues. Adjusted EBITDA increased 8.4% to $73.2 million in Q2 2019 compared with $67.5 million in the prior-year period. The increase was primarily due to higher revenues, combined with relatively flat year-over-year expenses, excluding the impact of currency. Adjusted EBITDA margins were 30.2% in the second quarter compared to 28.3% in the second quarter of 2018. We are required to report stand-alone adjusted EBITDA on a last 12-month basis pursuant to the reporting covenants contained in our credit agreement and indenture. Stand-alone adjusted EBITDA takes adjusted EBITDA and includes 2 permitted add-backs. Firstly, an adjustment for excess stand-alone expenses and, secondly, it includes the impact of pro forma cost savings we have implemented. Stand-alone adjusted EBITDA was $315.9 million for the 12-month period ended June 30, 2019, compared to $305.8 million for the 12-month period ended June 30, 2018. Turning to cash flow. For the 6-month period ended June 30, 2019, cash flow from operations increased nearly 38% to $42.9 million, up from $31 million in the prior-year period. Within cash from operations, we experienced certain working capital component changes in the 6 months ended June 30, including a change in cash flows for accounts receivable reflecting the collection of receivables related to annual renewals and a decrease in the change of accrued expenses related to timing of the receipts on payment of vendor bills. Capital expenditures for 6 month ended June 30, 2019, were $24.9 million, slightly above last year's same period. Free cash flow improved $18 million for 6-month period ended June 30, 2019, up from $6.8 million in the prior-year period. It is important to note that the current period includes approximately $30 million of merger-related cash expenses. Turning to the balance sheet. Cash and cash equivalents totaled $43.1 million at June 30, 2019 compared to $25.6 million at December 31, 2018. Total debt outstanding, net of cash, was approximately $1.3 billion at June 30, 2019, compared to $2 billion at December 31, 2018. Our net leverage ratio at June 30, 2019, was 4.1x compared with 6.4x at December 31, 2018.
Outlook. Jerre covered our outlook for 2019, which remains unchanged. Adjusted revenues in a range of $962 million to $995 million, adjusted EBITDA in a range of $290 million to $310 million. And adjusted EBITDA margins of approximately 30%. And I'll remind you that earlier this year, the company provided Clarivate lenders and Churchill investors an outlook for stand-alone adjusted EBITDA and that outlook is unchanged as well at between $325 million and $345 million. You'll notice in the appendix of the investor presentation, that we've included this slide with both historical quarterly adjusted revenues, by product line and group, and consolidated adjustment EBITDA for 2018 to help you with your financial modeling. We've also included the slide explaining the diluted share count to assist you with your analysis. With that, I'll now turn the call back over to Jerre.
Good job, Richard. Thanks. This wraps up our discussion of the second quarter. We look forward to sharing the many exciting opportunities ahead with you. Thank you for your time. We're now ready to take your questions. As a reminder, please limit yourself to 1 question and then return to the queue. Operator, let's open.
[Operator Instructions] The first question is from Tim McHugh of William Blair.
Just wonder if you can elaborate on the feedback from that first customer survey. I know you said the big conclusion was that, you realized you should make it easier to do business with Clarivate. Was that not known? And was it surprising, I guess? And as you got into the details, how was that perception different than people thought previously?
It's a great question, Tim. What wasn't known was by how highly valued our customers place with our products in all that we provide. That was, like I said, as high as we've seen. What I said in the script and it holds true, it was not a surprise to us that we were not perceived at all with being an easy-to-do business with the company. You may remember some of you that I actually, back in my IHS days, looked very hard at acquiring Clarivate and that was true then. And I would say the difference between 2012 and the end 2018, it was even more so. So we're -- I feel really good about it. We've got a dozen things that are undergoing. We'll fix that, that's 100% in our control. I think, the thing -- it's a great question because it's critical.
I talked about how important culture is, I can tell you operating with a sense of urgency, being externally focused, looking outside in, making sure that we operate with a great sense of urgency and clarity and getting rid of bureaucracy every place we're at, will help us do that and we'll do it quickly. We've also done a lot of other things is internally because it's critical that we remember -- I think of the world as inside customers and outside customers, with line of sight to the outside customers. So I will tell you I look forward to the next survey. As you probably know, as consumers, it'll take a year probably to prove how good we can be, and will be with easy-to-do-business, but we'll see improvements and we'll cover those each quarter. So no surprises at all other than a good news surprise from how they value us. One last comment I'll make. We scored very high, in fact, I felt very good about it, with the value that our customers look at us. So as we fix, and we must crack the issues, including ease of use with our products, et cetera. As we fix those, it's clear that selling, as I said, one of our key strategies, value selling gives us a lot of room for the future.
The next question is from Zach Cummins of B. Riley FBR.
So just based on actually building of your little bit of commentary at the end. Can you talk about the switch from a product-based sale strategy to now a more value-based strategy for the sales team and what that really means and implications going forward?
Yes, great question. Just as a reminder for everybody, this was by managed just as 5 silos, actually reporting to different parts of Thomson Reuters over the years. Bringing these silos together and consolidating into 2 groups, our Science group and our IP group, is already a huge step underway to make sure that we start cross-selling, to make sure that we start bundling and to make sure that when you go forward, we don't sell a product, we sell a solution to customers. I'm very pleased with the work that is underway by our top execs to do that in both places. I mean you can -- I can give you an example after example, but for example, Annette and Mukhtar when they first started talking about bringing a Web of Science and Life Sciences together, they quickly identified about $5 million of potential cross-selling revenue we'd never touch. There is a lot more of that to come. And it includes -- your question so critical, it includes a lot of training for our sales force. That's underway. I've been speaking every other week since I've been here to the different training programs that are underway and their leadership. And I think it's important to note this is the first year that we've been organized for our businesses, and the 2 groups I was talking about, have sales force inside of their organization. To put it bluntly, there was a real disconnect historically. It's not a way to run a railroad, when you've got someone in charge of sales that's not inside of the business. So we'll see the progress of that to come. It’s a great question.
The next question is from Ashwin Shirvaikar of Citi.
Questions on the Science group. The growth seems to have stepped up. Now is that a function of sales capacity being added? You are already seeing some benefits from product improvements, if you could break it down a bit and what milestones should we now expect, say, in the next 12 months in that group?
Yes. It's a great question. I'll start, and have Richard pick up on it. Some of the programs that have been put in place since Annette and Mukhtar have been leading the 2 science businesses are kicking off and they are starting to pay off, and I feel very good about those. I'll be even more excited as we said a minute ago, as we merge the 2 in the years ahead. But Richard, give a little detail on that.
Yes. I mean the quarter was particularly strong in the Science group, the subscription growth. I think the work that Annette and Mukhtar have done on their product strategy and having end-to-end offerings for the communities they serve is really starting to pay dividends. And we also get attractive price yield as well from the Science group. So those are the principal drivers.
Great question, Ashwin. Thanks.
The next question is from Pete Christiansen of Citi.
Richard, I noticed that the projection for excess stand-alone costs went up this quarter by a bit, $23 million to $31 million. Can you just talk about some of the delta that you're seeing there? And should we think of the current estimate kind of staying steady for the remainder of this year?
Yes. No, great question. We reaffirm that guidance. Richard, give them the particulars on it.
Yes. So we did increase it given the fact that we've just come out of the first quarter where we completed all of the transformation and separation from TR. What we're now doing is, we're optimizing that cost base. We have Boston Consulting Group with us working across the business looking at structure and looking at our run rate costs and that exercise will result in our general costs coming down and also our stand-alone costs being optimized as well. So something we'll be working very aggressively on over the next 2 quarters.
With more to come at the end of this quarter -- at the end of Q3 on that subject. Thank you. Next question.
[Operator Instructions] There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Jerre Stead for closing remarks.
Thank you very much. We've got a lot going on, we're very eager to share it with you the last comments that were made by Richard and I will give you little foresight what you can expect in the Q3, which is, us giving you an update on the progress we've made with our leadership team on streamlining the business, becoming much more efficient, much more effective, and then that will be November -- I'd get it wrong...
November 5.
I always think 4th. November 5. And on November 12, we look forward to having all of you together to give us an opportunity to share with you for the first time the great products and solutions that we provide for our customers. So I'll wrap up by saying thank you all, very pleased with the progress, and we're just getting started. We're going to go, go, go for the future. Thank you all very much.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.