CCSI - Consensus Cloud Solutions: To Stay Away Until There Is More Visibility

Summary

• Consensus Cloud Solutions missed its revenue and EBITDA estimates in 4Q22 and expects a challenging macro environment to persist throughout FY23.
• The company disclosed accounting issues, which raise concerns about its internal controls and processes.
• I recommend to exercise caution and stay away from investing in the CCSI stock until there is more visibility.

Overview

I think Consensus Cloud Solutions ( CCSI ) stock chart is very representative of its earnings – basically horrible with potential for more red flags. Revenue for 4Q22 came in at $90.2 million for CCSI, which was short of the consensus estimate of $95.8 million, and EBITDA was $49 million, also short of the consensus estimate of $51.2 million. In particular, management stated that the timing of both customer decisions and implementation contributed $3 million to the operational miss compared to their guidance. Management now expects revenue of $370–390 million in FY23 (low end of long-term guidance) and adjusted EBITDA of $192–206 million (around 52% margins). Management discussed on the call their anticipation of ongoing macro pressure, which they believe will lead to extended deal cycles and heightened budget scrutiny, especially among medium-to-large enterprise customers, who are increasing their scrutiny on budget spending. As such, management expects growth at the low end of guidance in the near term, with expectations for double-digit growth in the longer term, once conditions return to normal. On top of all these, we have CCSI announcing accounting issues. While the accounting issues did not distort any earnings and EBIT, it does raise eyebrows on how can they let this happen.

All these prove that I was right on my initial post that the right time to invest is only when we have more visibility in the growth business. And we still do not have them. I reiterate my recommendation to stay away from investing in the stock.

Weak macro is a problem

As mentioned above, challenging macro conditions are expected to persist throughout FY23. I think this is pretty much expected by most investors as it is a common thing across many industries. The common theme is scrutiny on budgets and slower decision-making process from large enterprise. My belief is that these large enterprises are pushing out any risky or non-core decision to as far out as possible so that they can sit through the pending recession, and also avoid any liquidity issues. This trend is likely to persist throughout the year, and it will likely have a negative effect on the churn rate for the Soho market as a whole due to the same factors. CCSI noted that, despite widespread predictions of inflation moderation, the firm is still experiencing wage inflation as a result of the current labor shortage. Given that wages are CCSI's single largest expense and that the company intends to boost its workforce in 2023, I anticipate a severe wage squeeze for CCSI in the near future, which could have a negative effect on its bottom line if new business is not successfully generated.

Accounting issues…

When there is a whole finance team on the case, I just don't see how mistakes like that can be made. The proverb goes that where there is one cockroach, there are thousands more nearby. Here's what went down: The company's management has disclosed two accounting mistakes that necessitated annual revenue restatements. The first is that the company overstated its Soho revenue by $5.3 million in the first three quarters of 2022 due to an incorrect accounting practice carried over from the CCSI spin-off in 2021. A corresponding bad debt expense was offset from this revenue error. However, it was noted by management that the error had no effect on operating profit or net income. Second, the company recognized $2.2M in revenue in 3Q22 that it is now reclassifying as deferred revenue due to an error in the timing of revenue recognition. In my experience, companies with accounting problems like these almost always have more than one incident like this.

VA deal

Nothing seems to be working well for CCSI. Management has acknowledged that its VA deal is progressing slower than initially planned, and that this is due in part to the delay in customer decisions. In an effort to salvage the situation, management has stated that the company is close to implementing ECFax at its first medical facility and that revenue from this deal should begin to materialize in the second or third quarter of this year.

Capital allocation

Despite the other bad news, it's comforting to know that CCSI does have an interest in repurchasing its own stock. When pressed on where they stand on the list of priorities for allocating capital, management made clear their aversion to M&A activity in the near to intermediate future. CCSI, however, is still keen on making share repurchases and paying off some existing debt. I like to note that CCSI cannot reduce its debt until October 2023. Management has also stated its intention to concentrate on internal growth and the launch of new products like Harmony.

Conclusion

CCSI earnings continue to reflect a challenging macro environment, with potential red flags such as accounting issues and slower VA deal progress. Management has acknowledged the ongoing macro pressure, which is expected to lead to extended deal cycles and heightened budget scrutiny, particularly among medium-to-large enterprise customers. Furthermore, the accounting issues raise concerns about the company's internal controls and processes. Therefore, it is advisable to exercise caution and stay away from investing in the CCSI stock until there is more visibility.

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