Solera Holdings, Inc. F4Q08 (Qtr End 06/30/08) Earnings Call Transcript

Aug.27.08 | About: Solera Holdings, (SLH)

Solera Holdings, Inc. (NYSE:SLH)

F4Q08 Earnings Call

August 27, 2008 5:00 pm ET

Executives

Kamal Hamid – Director, Investor Relations

Tony Aquila - President, Chief Executive Officer & Director

Jack Pearlstein - Chief Financial Officer, Treasurer & Secretary

Analysts

Peter P. Appert – Goldman Sachs

Gary Prestopino – Barrington Research

Andrew Jeffrey - SunTrust Robinson Humphrey

David Lewis – JP Morgan

[William Manta – Citi]

Operator

Welcome to Solera’s fourth quarter fiscal year 2008 earnings call. (Operator Instructions) At this time I would like to turn the call over to Kamal Hamid, Director of Investor Relations at Solera.

Kamal Hamid

Today on the call with me are Tony Aquila, our Founder, Chairman and CEO and Jack Pearlstein, our Chief Financial Officer. Tony will begin today’s call with a summary of our financial results for the quarter and year ended June 30, 2008 followed by an update on some of the macro trends driving the business. Jack will then comment further on our financial results for the fourth quarter and finish with a discussion of the company’s fiscal year 2009 guidance. We will then open up the call for questions and concluding remarks from Tony.

Before we begin I’d like to remind everyone that our remarks during this conference call will contain forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are neither promises nor guarantees but involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements including, without limitation, those risks detailed in Solera’s filing with the SEC including our most quarterly report on Form 10-Q for the quarter ended March 31st, 2008. We disclaim any obligation to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based or that may effect the likelihood that actual results will differ from those set forth in the forward-looking statements.

We also plan to discuss certain non-GAAP financial measures on this call. A reconciliation of those financial measures to GAAP financial measures is included in today’s press release which is available on the investor relations section of our company’s website at www.SoleraInc.com. When we refer to consensus during this call we mean the consensus results of certain analysts that cover the company as reported on Thompson’s First call. All information discussed during this call and webcast is protected by US Copyright Law and may not be reproduced, distributed, transmitted, displayed, published or broadcast without the prior written permission of Solera Holdings, Inc.

I would now like to introduce Tony Aquila, our Founder, Chairman and CEO.

Tony Aquila

I’ll start by giving you an overview of the financial highlights for the quarter then give you our view on some of the macro economic trends we are seeing and then before turning the call over to Jack tell you about our direction and focus for fiscal year 09.

I am pleased to report another strong quarter and a successful finish to our fiscal year 08. Our record Q4 results demonstrated solid top line momentum as we continued to execute our global business strategy. This growth and the fact that our evolving markets are increasing becoming a larger portion of total revenues resulted in Q4 organic growth of approximately 8.9% up by about 240 basis points versus Q3 2008. Our fourth quarter revenue of $145.5 million was up by almost $23 million and 18.8% over the prior year period. At the same time the natural leverage in our business model coupled with our waste reduction efforts benefited our overall margins. Our total cost of revenue for the fourth quarter declined by $1.3 million versus the prior year period which together with the revenue growth resulted in an adjusted EBITDA margin for the quarter of 35%.

Since our last call the macro environment has been changing. Slowing global economies coupled with high gas and oil prices have negatively impacted the number of miles driven and the rate of new car sales in many of our markets. To date however we have not, and I repeat, we have not seen a strong correlation between the reduction in the number of miles driven and the frequency of claims volume in our business. We believe part of the reason for the lack of a strong correlation lies in the fact that it predominantly the long haul rule miles that are being cut by drivers versus the short urban miles driven around town where accidents occur at a much higher frequency rate. In New York state for example through June 30th, 2008 year-over-year accidents are up despite the over $1 increase in the price per gallon of gas. On a global basis although continued economic softness and high gas prices have and will likely continue to result in a near term slowdown of new car sales and lower overall miles driven. We believe the underlying trends in the business will offset this potential softness and allow us to continue to grow.

These trends include one, continued growth in the number of vehicles on the road that are becoming insured; two, the continued migration of paper based estimating to electronic estimating in evolving and emerging markets; and three, continued purchase of additional products and services by our customers as they further automate their business processes. So consistent with our prior statements even in the current economic environment we believe we can continue to grow our top line 6% to 8% on an organic basis.

Our 8.9% organic growth for the fourth quarter was our best since we acquired the business in April of 2006. While we benefited slightly from some one time items and the number of business days during the quarter the success we are seeing in both our mature and evolving markets is clearly the driver behind this top line momentum. Our Central and Eastern European markets grew better than 30% and our Latin American markets grew by better than 20% compared with the prior year period. Combined the two regions contributed approximately 10% of our total revenues in the fourth quarter up from approximately 8% in the prior year. On the acquisition front we’ve talked about our efforts over the last two quarters to build out our corporate development team and expand our pipeline of acquisition opportunities. This effort is beginning to pay off. Last month we announced the acquisition of UCS, one of the leading providers of body shop management systems in Germany.

Now I’d like to make a few comments about our 80/20 themes for fiscal year 09. At the time of our IPO we talked about our Drive to 35, our goal of growing our adjusted EBITDA margins to 35%. With this quarter’s results we achieved this multi-year goal a little sooner than we had projected and we are now setting a new multi-year target called our Strive for 37.5. Adhering to our rule of 3 and keeping things simple our primary themes for fiscal year 09 will be to one, continue to invest in new markets; two, more aggressively pursue strategic acquisitions; and three, continue to bring innovative products and services to our customers by leveraging the size and scale of our database software development and our overall business.

Jack will now take you through the financials and then I’ll do a brief wrap up after we do some Q&A.

Jack Pearlstein

As mentioned at the top of the call we are pleased to report on our fourth quarter fiscal year 2008 results. Our revenues of $145.5 million were up 18.8% over the prior year period. Our fourth quarter organic growth was approximately 8.9% the result of solid business execution, the number of business days and a handful of one time items that totaled approximately $1 million. Our Americas revenue grew by 8% to $52.6 million while our AMEA revenues grew by 25.9% to $92.9 million. There were several notable markets in 4Q other than Central and Eastern Europe and Latin America that were highlighted by Tony. Revenue growth in the fourth quarter versus prior year period was 7.4% in Canada, 13.2% in Spain, 15.2% in the UK and 20.5% in France. Our fourth quarter adjusted EBITDA came in at $50.9 million a 35% margin and up more than 300 basis points over the prior year period.

During the fourth quarter our total cost of revenues increased by $2.1 million over the third quarter but declined as a percentage of revenue to 35.3% from 35.6%. Our SG&A costs were up $1.7 million sequentially but also declined as a percentage of revenue to 29.3% from 29.6%. SOX costs and the continuing build out of our corporate organization contributed in part to the $1.7 million increase during the quarter. As highlighted in our press release today our fourth quarter tax provision of $26.7 million includes an approximate $30 million valuation allowance for deferred tax assets pursuant to the requirements of FAS 109. A majority of this valuation allowance was related to cumulative net operating losses incurred by several of our US entities. Under FAS 109 the deferred tax asset is reduced by a valuation allowance when it more likely than not that the deferred tax asset may not be realized. An important factor in assessing the need for this valuation allowance is our history of losses in the US since our acquisition of the claims services group from ADP in April of 2006.

These losses are primarily driven by interest expense and tax deductible amortization of acquired intangibles a by product of the structure of the acquisition itself. To the extent we have taxable income in the US in the future we would record a benefit for GAAP purposes from these NOLs and credits. Although no assurances can be given such taxable income could occur as early as fiscal 2009. Offsetting the valuation allowance in the fourth quarter was a tax benefit of approximately $11 million resulting from the jurisdictional change that lowered the tax rate of one of our Swiss holding companies. As opposed to the valuation allowance which is more one time in nature we believe the jurisdictional change and the lower resulting tax rate will benefit us on a go forward basis. As stated in our press release we believe the jurisdictional change among other factors will result in a long term effective tax rate for the company of approximately 28%.

In the fourth quarter we also took a restructuring charge of $10.4 million primarily for termination benefits and severance costs associated with waste reduction efforts in the US and Germany. This charge was slightly larger than anticipated as we accelerated restructuring efforts from Q1 of 09 into 4Q of 08. By the end of fiscal year 09 we estimate that these waste reduction efforts will result in additional annualized savings of approximately $5 million to $6 million per year.

Adjusted net income for the fourth quarter came in at $22.2 million up nearly 52.4% over the prior year period and adjusted net income per diluted share was $0.34 $0.04 ahead of consensus. Due primarily to the FAS 109 valuation allowance and restructuring charges in 4Q we incurred a GAAP net loss of $21.6 million or $0.33 per diluted share. We ended the quarter with $149.3 million in cash and we had total debt outstanding of $630.9 million. We paid down approximately $16 million of debt during the quarter and ended the year with a total leverage ratio of 3.17 times as defined by our credit agreement. At total leverage levels below 3.25 times our applicable margin is 175 basis points versus the 200 basis points that we had throughout fiscal year 08.

Cash flow form operations was approximately $37 million for the quarter bringing the FY 08 total to approximately $117 million. Accounts receivable at quarter end was approximately $95 million which translates to DSOs of roughly 59 days. Capital expenditures for the quarter was approximately $6.2 million when including principal payments for cap ex being financed of approximately $1.3 million.

In this afternoon’s press release we issued our initial guidance for the upcoming fiscal year. For fiscal year 09 we are making two small modifications to our methodology for calculating adjusted net income and adjusted net income per share. The first is to carve out and add back interest income that has historically been included in our other income expense line and thereby excluded from prior calculations and the second is to lower our tax rate from 33% to 28% which approximates our updated view of our long term effective tax rate. For fiscal year 09 therefore we estimate revenues to be between $570 million to $580 million, adjusted EBITDA to be $200 million to $205 million, GAAP net income to be between $40 million and $45 million, adjusted net income to be between $97 million and $102 million and adjusted net income per diluted share to be between $1.45 and $1.55.

The midpoint of these new guidance ranges represents year-over-year revenue growth of approximately 6.5%, year-over-year adjusted EBITDA growth of approximately 9.2%, year-over-year adjusted net income growth of approximately 26.4% and year-over-year adjusted net income per diluted share growth of approximately 23%. As stated in the press release earlier today these figures assume relatively constant currency exchange rates from those prevalent today, no acquisitions and to calculated adjusted net income a 28% tax rate. For fiscal year 09 we expect our capital expenditures to continue to be in the range of $20 million to $25 million and our fully diluted share count to increase by 1.5% to 2% over the course of the year which assumes no stock issuances associated with any potential acquisitions.

We expect fiscal year 09 stock comp expense to be in a similar range to fiscal year 08 and we expect fiscal year 09 depreciation and amortization to be in the range of $16 million to $18 million and $67 million to $70 million respectively. In terms of priority for the use of cash as in the pat we will continue to pay down debt as a primary use of cash. In addition we may also use cash to fund acquisitions.

That concludes our prepared remarks. We will now take your questions and then Tony will provide a brief wrap up.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Peter P. Appert – Goldman Sachs.

Peter P. Appert – Goldman Sachs

Tony on the acquisition front what’s the pipeline look like, how active do you think you can be in fiscal 09?

Tony Aquila

It’s our coming out year, Peter. We feel pretty good about the pipeline, it’s regionally focused for the things that we’re focused in on and we feel pretty good about it at this stage in the year. So I think more to come and you’ll see us talk about things as the quarters roll out.

Peter P. Appert – Goldman Sachs

Sort of the scale of the German transaction, is that what we should be looking for?

Tony Aquila

We had discussions with many of you over the quarters and you’ll see us do more tuck in smaller type stuff that’s accretive to us and then in the mid-term we’ll probably move up into a few larger deals before we get into something of any kind of size.

Peter P. Appert – Goldman Sachs

On the M&A front any thoughts on progress with the CCC Mitchell deal, how quickly you think that can get done or if it’s going to get done?

Tony Aquila

Consistent to what we said in the past we really don’t have any comment. We know that the FTC is currently doing their investigation and we’ll see as things play out on that front.

Peter P. Appert – Goldman Sachs

This is for Jack, in terms of the margin drivers over the next couple of years, can you give us a little help in better understanding how you get to the 37.5% and what you think the upper limit is in terms of what the margin potential in this business could be?

Jack Pearlstein

I think Peter in prior quarters and consistent with what we’ve talked about in the past, I think the way margins grow is really on flow through. I think this is a leverageable business, it’s a leverageable business model and it shouldn’t cost us a whole lot of money in theory to process another 1,000 claims or sign up an extra 20 subscribers. You’ll continue to see revenue grow faster than expenses and I think you’ll see that additional flow through make it down to the margin line and I think that’s how you get to 37.5%. In terms of setting an upper range or an upper cap there we’ve historically stayed away from that and would probably beg to take that same position here on the call.

Peter P. Appert – Goldman Sachs

Just to be clear, Jack you said the 37.5% is meant to be again the three year target?

Jack Pearlstein

I think we said multi-year target.

Tony Aquila

Peter, I think if you just look at consistently to the way we’ve done things I would call it a two to three year target.

Peter P. Appert – Goldman Sachs

Finally in terms of the international business you gave us some color on the different markets which is very helpful, thank you and you also commented on how the impact of the higher gasoline prices you don’t see as flowing through. In these markets internationally where you’re paid on a unit basis has there been any flow through in terms of unit volumes particularly in the shop business from these macro forces?

Tony Aquila

To date, Peter, we have seen nothing that has caused us to correlate the two and that’s why we take the view that these are a lot more rural miles being hit rather than urban miles and additionally you also have insurance adoption flowing through in these markets so there may be some minor impacts going on but because we’ve got the better end of the growth curve we’re not feeling it.

Jack Pearlstein

The only thing I’d add to that, Peter, is when we look at claims volumes for us for Q of 08 over 4Q of 07 which pretty much correlates with the rise in gas price and the slowing we actually see in our mature European market claims volumes up 4Q 08 over 4Q 07. So again, no correlation to date.

Peter P. Appert – Goldman Sachs

This is really the last item, in terms of pricing how should we think about that going into fiscal 08?

Tony Aquila

I think our view is very consistent with what we’ve performed in 08, we don’t see anything that’s causing us any great alarm at this point in time and we’re just maintaining a steady pace.

Peter P. Appert – Goldman Sachs

Translate that, Tony, into numbers then please? What does that mean in terms of what percentage of the 6% to 8% organic growth rate is pricing driven versus unit driven?

Tony Aquila

It’s got to be less than 1%. It’s consistent with what we said about price. We have really not gone at a price game in anything that we’ve done in the past here, Peter. As you probably remember in some of the other discussions we’re maintaining the same position.

Operator

Our next question comes from Gary Prestopino – Barrington Research.

Gary Prestopino – Barrington Research

Tony, just a couple of quick questions, in terms of the macro you gave three factors that are driving the growth, number of vehicles being insured, migration to an electronic and then products and services. Could you for us rank order of them in terms of what’s going to be the biggest to the lowest growth driver for the next year?

Tony Aquila

The reason why we picked those three things is because there’s different things going on in different markets. In mature markets you’re going to have number three be a bigger driver. In the evolving markets you have all three going on and in the emerging markets it’s just purely penetration, it’s adoption.

Gary Prestopino – Barrington Research

Could you talk a little bit about how you’re doing with your startups in Turkey and Australia and then what we can look for from Italy for this year?

Tony Aquila

We’re not projecting anything for Italy for this year. The Italian market is a market that takes some time. I’ll be over there in a couple weeks again. We believe we’re laying a good foundation but we’re not projecting anything for it. Our Australian operations, our pilot phases are moving based on our plan. In Turkey we’re lining up the right relationships. We’ve got a good partner, some of our carriers in other markets are there as well as in Australia and again though we’re not projecting any revenue in those either. If that happens it’s just going to be a bonus but we’re still in the development phase of launching those markets from the way we’ve projected out the numbers for fiscal year 09.

Gary Prestopino – Barrington Research

In terms of products and services, I always call them add on products that you talked about to get somebody to take a full suite of your products and services. What are some of the key things that you’re seeing there in terms of other than the electronic claims processing, some of the services that you’re selling that are hoping to drive growth?

Tony Aquila

That’s one of the things that we do with these countries is we run a pretty decentralized business for the most part but we offer a lot of coverage from across the globe. Some of the things that they’re picking up on it’s analytical stuff in nature, those kind of products and services, more MIS trend information, they’re very concerned about everybody talking about miles driven and all this stuff, although they’re seeing increases in claims, they’re trying to get a handle on it. Additionally fraud detection type services like VIN and other components of that, we’re seeing that across all three categories. Additionally the addition of trucks and some of these other mobility items. There’s a list of things that are going on as well as property services, we’re seeing them wanting to use a bit of a broader reach, wanting to understand if the platform can go farther than just auto and those kind of things. Does that answer your question, Gary?

Operator

Our next question comes from Andrew Jeffrey - SunTrust Robinson Humphrey.

Andrew Jeffrey - SunTrust Robinson Humphrey

Could you talk a little bit, I know it’s early days still as far as CCC Mitchell but I noticed a little bit of an up tick obviously in your domestic revenue growth, do you think there’s anything either market disruption, management distraction or anything discernible that may be changing competitively there and further assuming the deal does get approved and go through in its current form, how much of that would you anticipate recognizing that the sale cycles are relatively long?

Tony Aquila

You know as well, Andrew, from these kind of things, naturally in the beginning if this was to go through there would be probably some opportunities that hadn’t been around for us will come around for us. We think that there’s some opportunities that can occur on that side of the front. I think it’s early to say anybody’s done anything. I think during this phase while the FTC is doing their thing, I think the markets are generally quiet. We benefited a bit because it was the strategy we put into place very early and those things were really not correlated. It’s business as usual right now and once the FTC finishes their thing I think we’ll have more. Whatever happens we’re going to make the best out of it, it’s just the way we’re going to run the business, we’re preparing for that and we’ll just keep our head down and see what happens.

Andrew Jeffrey - SunTrust Robinson Humphrey

So suffice to say your 09 revenue growth guidance, at least from the domestic standpoint, doesn’t consider much of a meaningful change from [inaudible]?

Tony Aquila

That’s correct.

Andrew Jeffrey - SunTrust Robinson Humphrey

So just better execution and if there’s market share, it’s a bonus?

Tony Aquila

Yes. We run a relatively conservative shop on that stuff.

Andrew Jeffrey - SunTrust Robinson Humphrey

With regard to gross margin which has steadily been improving I realize you’re reluctant to throw our a long term EBITDA margin target and that’s understandable although the goal I think longer team speaks for itself. Could you frame up a little bit where you think gross margin can go particularly as in your evolving markets you begin to scale some of these databases which have been a rather significant current period expense?

Tony Aquila

We’ve been really studying throughout the year and executing where we have the appropriate factors in place. The nice thing about the way we’ve assembled the model is we’re working labor arbitrages so these evolving markets are generally getting bolted to mature markets in regions and we’re picking up a natural arbitrage and sometimes those arbitrages are pretty handsome. As we localize the work we’re conjoining them with other mature markets and they’re actually helping those mature markets get more profitable. Does that make sense?

Andrew Jeffrey - SunTrust Robinson Humphrey

Yes and can I infer that that’s a multi-year process, that’s not something that happens overnight, right? Hence, the improving trends?

Tony Aquila

Generally we’ll make a move with a couple quarters of studying and understanding and then because we’re doing the work on that evolving country the actual ability to execute that, to conjoin it with the mature country actually gets accelerated. Because you’re already doing work for that country in that country and then to just broaden out that workforce you actually get the up take and so it’s going to help us. It’s continuous, we constantly analyze it and every region as to be put forth various opportunities based on those arbitrages.

Jack Pearlstein

Andrew, I’d say if you would consider 1% overall margin improvement, operating margin improvement, probably two-thirds of that would come from your cost of revenue line and a third, just ballparking, would probably come from the SG&A line over time, however you tee up your model that would probably be a decent theoretical rule of thumb.

Andrew Jeffrey - SunTrust Robinson Humphrey

So in other words look for gross margin to keep widening out?

Jack Pearlstein

Correct.

Andrew Jeffrey - SunTrust Robinson Humphrey

Finally, to the extent that you’ve put a little more emphasis on the shop side, sales effort and I think this is probably more applicable in the US, but it may also be germane internationally, I can see why the insurance company vertical is going to continue to spend given the secular trends. Is there a greater relative cyclical risk at the shop level given smaller budgets and maybe capital constraints and might we see the first signs of any cyclicality? Should there be any in that revenue stream?

Tony Aquila

The purchases shops make with us are generally not discretionary purchases, these are essential purchases in the way they do business. If you look back in history to the various turbulent times revenues have been pretty stable in there. To the extent we sell anything that is discretional to the shops which would be in the sub-10% of the offering to the shop market in our portfolio, then you could look at those as being at risk. But in our portfolio we don’t have very much discretionary activity with shops, it’s all essential. In order for them to trade with the insurance companies they’ve got to be hooked up. We’re right along with the power line.

Operator

Our next question comes from David Lewis – JP Morgan.

David Lewis – JP Morgan

Have you seen any change in the conversion from paper to online, whether it’s accelerating or decelerating in any specific region or is it generally trending along at the same pace?

Tony Aquila

It’s moving just as we had projected.

David Lewis – JP Morgan

Second question is could you disclose the benefit from number of business days year-over-year, what that contributed to the top line?

Jack Pearlstein

You’re looking at one business day which if you take what the revenue per day was in the quarter it probably gets you to about $1.5 million.

Operator

Our final question comes from [William Manta – Citi].

[William Manta – Citi]

What was your organic revenue growth for fiscal year 08 please?

Jack Pearlstein

In total it was 7.3%, 7.4%.

Tony Aquila

That will wrap it up for questions. Fiscal year 2008 was a year of strong growth for Solera. We consistently executed our plan and exceeded expectations while at the same time ceding investments that we think will allow us to continue to build momentum. We’re extremely excited about our prospects for fiscal year 09 and beyond as we believe we’ll continue to execute, grow and incorporate a handful of strategic acquisitions. Lastly, I want to thank each and every one of our 1,878 associates for a job well done. Your hard work and dedication have resulted in our continued success. With a clear focus on our strategic priorities we are committed to enhancing shareholder value. Thanks again for joining us on the call and we look forward to speaking with you again next quarter. Thank you everyone.

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