Donnelley Financial Solutions Inc (DFIN) 2017 Q1 法說會逐字稿

Welcome to the Donnelley Financial Solutions first-quarter 2017 results conference call. My name is Erik and I will be your operator for today's call. (Operator Instructions). Please note that this conference is being recorded. I will now turn the call over to Sanja Burklow. Sanja, you may begin.

Thank you, Erik. Good morning, everyone, and thank you for joining Donnelley Financial Solutions' first-quarter 2017 results conference call. This morning we released our earnings report, a copy of which can be found in the Investors section of our website at dfsco.com.

During this call we will refer to forward-looking statements that are subject to uncertainty. For a complete discussion please refer to the cautionary statement included in our earnings release and further detailed in our annual report on Form 10-K and other filings with the SEC.

Further, we will discuss non-GAAP and pro forma financial information. We believe the presentation of non-GAAP and pro forma results provides you with useful supplementary information defending the Company's ongoing operations and is an appropriate way for you to evaluate the Company's performance. They are, however, provided for informational purposes only. Please refer to the press release and related footnotes for GAAP information and the reconciliation of GAAP to non-GAAP information.

We are joined this morning by Dan Leib, Dave Gardella, Tom Juhase and [Kami] Turner. I will now turn the call over to Dan.

Thank you, Sanja, and good morning, everyone. On today's call I'll provide an update on the first-quarter performance, what we are seeing in terms of market activity, the progress we have made in repositioning the Company to operate independently and highlight some of our strategic priorities going forward. Following my comments Dave will provide additional detail on our first-quarter results and then we will open up the lines for a Q&A session.

We are pleased with our first-quarter results; they reflect the improving market environment for M&A and IPOs of which we spoke on our last call, strong sales and operational performance within these improved markets and the benefits of our cost reduction efforts.

Compared to a relatively weak first quarter of 2016, organic revenue increased 11.9% and non-GAAP adjusted EBITDA increased 37%. Free cash flow reflected normal seasonal patterns but was good on a comparative basis with this year's results, including interest costs associated with being a standalone Company.

While we are only one quarter into the year and considering the strong market influence to our results, we slightly increased our full-year guidance for revenue, EBITDA and free cash flow. Activity levels improved across the board in the first quarter. Compared to the first quarter of last year we experienced double-digit revenue growth in both our US and International segments.

Further, each of our reporting units within the US segment contributed to the strong growth. Our capital markets offering grew 11.5% driven by 38% growth in our Venue data room software offering, as well as an increase in our transactional revenue which grew by 30%. Similarly our investment markets offering grew by nearly 10% driven by strong growth in our content management offering and incremental proxy revenue from some of our mutual fund clients. Our Language Solutions reporting unit also grew by nearly 10%.

On the capital markets side our first-quarter results reflect the healthier transactional activity in the market and continued significant growth in our Venue data room offering. Though the secular decline in the number of public companies negatively impacts our compliance-based solutions, we continue to invest in our client facing tools and expand the use cases, as well as leverage the strengths of our partnerships to provide our clients with best-in-class solutions for their most complex data management and compliance needs.

We are encouraged by and are benefiting from our differentiated product solutions and diversified customer base which includes private equity, venture capital and law firms. A market release of ActiveDisclosure that begins to incorporate the functionality of Microsoft Office 365 will occur this month. We continue to invest in ActiveDisclosure to engage more intimately with both private and public companies alike in order to drive additional recurring revenue.

In addition, with our recently announced investment and renewed strategic partnership with SOXHUB we are able to help our clients more efficiently manage their SOX requirements.

In our investment markets offering our clients continue to rely on Donnelley Financial Solutions to provide efficient content management, production and workflow solutions to help reduce their costs. This approach differentiates us from our competitors and we are proud that our client retention rate has remained consistent given ongoing regulatory change.

Our investment markets offering provides a strong base of recurring revenue and we remain focused on driving growth in this area. We are engaged with our clients as they address operational challenges related to a complex and ever-changing global regulatory environment. We anticipate during the balance of 2017 that the US investment markets industry will be tasked with solving the data and reporting requirements associated with new and proposed regulatory changes like report modernization, the liquidity rule, the derivatives rule and the fiduciary rule.

On the International front key EU regulatory initiatives such as AIFMD, MiFID II and PRIIPS are also driving industry need for data-driven technology enabled regulatory and compliance solutions. Donnelley Financial stance well positioned with our FundSuiteArc content management platform to help our clients as a trusted partner to deliver a suite of compliance solutions to help them manage evolving global regulatory demands.

In our global Language Solutions offering first-quarter revenue growth was driven by a combination of growth with existing customers and new customer wins. We expect continued growth in this area driven by a variety of services within the Language Solutions offering including transcreation, website localization, video dubbing and subtitling and post machine translation editing.

Regarding our October 1 spinoff from RR Donnelley, we continue to make significant progress in positioning the Company for long-term success. As was previously noted, we are rightsizing the cost structure, are prioritizing our investment needs and identifying new market opportunities.

From our continued organic investments in ActiveDisclosure, Venue, FundSuiteArc and MultiTrans, to our investments in strategic partnerships such as with SOXHUB and Mediant Communications, we continue to take a thoughtful but aggressive approach in strengthening our portfolio of products and services and bringing a wide array of governance, risk management and compliance-based solutions to market.

These solutions will allow us to broaden our portfolio and further enhance our client relationships which, balanced with cost management and resource allocation, provide opportunity to create long-term value for shareholders.

With respect to our operating plan for 2017, I'd like to reiterate a few of our key priorities. First, we will continue to build on the momentum that we have created in the areas where we have seen significant growth such as the Venue data room, our global Language Solutions offering and our content management solutions within our investment markets reporting unit.

Second, we will continue to make enhancements across each of our technology-based solutions from our ActiveDisclosure collaborative workflow tool and Venue data room to our FundSuiteArc content management platform and our Language Solutions MultiTrans software we remain focused on delivering product enhancements and improving our clients' experience with these tools. We expect such enhancements to be the result of a combination of organic investment and expansion of our relationships with strategic partners.

Third, we will continue to aggressively pursue the transactional activity within the Global Capital Markets.

As I mentioned earlier, 2017 is off to a stronger start than what we saw in the first quarter of 2016 and our client relationships and reputation in this space position us well to capture this revenue as transactional activity continues to recover from the levels we experienced throughout last year. And we will accomplish each of these priorities while taking a disciplined approach to managing our cost structure and deploying capital. Let me turn it over to Dave. Dave.

Thank you, Dan, and good morning, everyone. As Dan mentioned earlier, we started the year on a positive note consistent with our expectations. Net sales for the first quarter were $267.3 million, an increase of $27.2 million or 11.3% from the first quarter of 2016. After adjusting for changes in foreign exchange rates, organic sales increased 11.9% driven by double-digit growth in both our US and International segments.

This strong revenue growth was driven by an improvement in capital markets activity, mutual fund proxy volume driven by two special proxies in the quarter, and growth from our Venue, ActiveDisclosure and FundSuiteArc software offerings.

First-quarter gross margin was 36.6%, 264 basis points higher than the first quarter of 2016. This includes approximately 250 basis points of a negative impact driven by a change in the classification of IT costs to cost of sales from SG&A compared to classification in prior periods -- periods prior to the separation from RR Donnelley. Excluding this reclassification first-quarter gross margin improvement of approximately 515 -- 514 basis points was primarily driven by higher transactional volume and the cost reductions we began to implement late last year.

Non-GAAP SG&A expense in the quarter was $52.9 million, $4.2 million higher than the first quarter of 2016. As a percentage of revenue SG&A was 19.8% or 49 basis points lower than the first quarter of 2016. Excluding the favorable 250 basis point impact of the IT reclassification, SG&A as a percentage of revenue was approximately 201 basis points higher than the first quarter of 2016.

As mentioned in this morning's press release, we incurred approximately $5 million in higher costs related to the dis-synergies and ongoing costs in excess of the cost historically allocated to the Company. These incremental costs were partially offset by the cost reductions we began to implement late last year.

Our first-quarter non-GAAP adjusted EBITDA was $45.0 million, an increase of $12.1 million or 37% from $32.9 million in the first quarter of 2016. Non-GAAP adjusted EBITDA margin in the quarter of 16.8% was 313 basis points higher than the first quarter of last year driven by higher transactional volume and cost reduction actions partially offset by stand-alone costs incurred in the quarter.

Now I will discuss revenue and non-GAAP adjusted EBITDA performance for each of the segments. Revenue in our US segment was $230.4 million in the first quarter of 2017, an increase of 10.7% from last year's first quarter driven by strong revenue growth in each of our offerings. Capital markets growth of 11.5% was driven by higher volume of IPOs, debt offerings and mergers and acquisitions and strong growth in our Venue and ActiveDisclosure offerings only partially offset by lower compliance volume.

Investment markets reported revenue growth of 9.9% due to higher mutual fund proxy volume which was driven by two special proxies in the quarter as well as higher content management volume. Language Solutions and Other reported revenue growth of 9.8% driven by higher volume in translation services as well as higher commercial print volume.

Non-GAAP adjusted EBITDA margin for the segment of 21% increased 611 basis points from the first quarter of 2016. Higher capital markets transactional volume and higher proxy and content management volume in investment markets as well, as cost savings actions we initiated at the end of 2016 were only partially offset by higher run rate costs for -- previously allocated from RR Donnelley.

Revenue in our International segment was $36.9 million in the first quarter of 2017, an increase of 15.3% from the first quarter of last year. On an organic basis, excluding the unfavorable impact of changes in foreign exchange rates, revenue in the first quarter increased 19.4% driven by improvement in capital markets transactional and compliance volume, higher mutual funds volume and continued growth in Venue and Language Solutions offerings.

Non-GAAP adjusted EBITDA margin for the segment of 6.2% decreased 658 basis points from the first quarter of 2016. The decline was driven by higher amounts allocated to the International segment including certain IT expenses which were allocated to the International segment starting in the fourth quarter of 2016.

Our first-quarter 2017 non-GAAP unallocated corporate expenses were $5.6 million, an increase of $3.5 million from the first quarter of 2016 driven by dis-synergies related to the separation from RR Donnelley and higher bad debt expense.

Free cash flow in the quarter was an outflow of $42.5 million, an improvement of $9.7 million from the first quarter of last year primarily due to higher EBITDA and lower capital expenditures partially offset by an interest payment in the first quarter of 2017 and higher restructuring-related payments.

First-quarter of 2017 cash flow includes an interest payment associated with the debt raised in connection with the spinoff from RR Donnelley whereas the first quarter of 2016 did not include any cash interest and only a de minimis amount of interest expense in the P&L.

We ended the quarter with $607.5 million of debt and $12.3 million of cash. As of March 31, 2017 our gross leverage was 3.5 times compared to 3.6 times at December 31, 2016 and we had net available liquidity of $182.6 million at the end of the first quarter.

These cash and debt balances, as well as our leverage ratio and available liquidity, do not reflect the impact of the $68 million cash payment received from RR Donnelley shortly after quarter end. We used the full $68 million to pay down our term loan in April and we remain on track to reach the top end of our targeted leverage range of 2.25 times to 2.75 times by the end of the year.

As we begin the second quarter let me share some additional detail around our full-year 2017 guidance. As highlighted in this morning's press release, we are modestly raising our full-year guidance ranges on revenue, non-GAAP adjusted EBITDA and cash flow to reflect the first-quarter performance.

As mentioned on our last earnings call, the Company's performance is largely dependent on global capital markets transactions activity and our guidance for 2017 assumes a modest recovery in this area for the remainder of the year relative to what we experienced in the same periods in 2016.

We expect revenue of approximately $1 billion representing organic growth in the range of 3% to 5% compared to our prior guidance of organic revenue growth of 1% to 2%. We expect our non-GAAP adjusted EBITDA to be in the range of $175 million to $180 million at the midpoint, an increase of $7.5 million from the midpoint of our previous guidance.

We expect free cash flow and the range of $50 million to $60 million, an increase of $5 million from previous guidance. We continue to expect capital spending in the range of $30 million to $35 million. However, we do expect capital spending to be more heavily weighted towards second half of the year compared to last year.

Included in this guidance is our expectations on dis-synergies and costs that were allocated to the Company prior to the spinoff, which, as we previously communicated, will result in an incremental $13.3 million of cost in 2017. Of the $13.3 million approximately $5 million of that cost was recognized in the first quarter with approximately $3 million expected to be recognized in the second quarter and the remaining $5.3 million expected to be recognized in the third quarter.

Regarding the $20 million of annualized cost actions that we communicated in February, the majority of these actions were taken at the end of 2016 and early this year and we remain on track to recognize the vast majority of the $20 million savings in 2017.

Before I turn it back to Dan I would like to provide a little more color on the year-over-year quarterly comparisons. As we look at the last three quarters of the year we expect the second quarter to have the most difficult year-over-year comparison of the remaining three quarters, specifically in the capital markets reporting unit, due to some unusually large transactions that were included in the second quarter of last year. And with that I will turn it back to Dan.

Thank you, Dave. In our first seven months as a standalone Company we have made several changes to improve our operating efficiency and have begun the work to reposition the Company for continued success going forward. We continue to strengthen our core offerings and are in the early stages of bringing additional compliance based solutions to market.

Lastly, I'd like to thank all of our employees. Since the October spinoff we planned and implemented many of the changes that I just noted. The unwavering focus of our employees, operational, administrative and client facing, has made our transition to a standalone Company go smoothly. Thank you for your hard work and continued focus. And now, operator, let's open it up for questions.

(Operator Instructions). Charles Strauzer, CJS Securities.

So, a few questions here. If you could start off -- maybe, Dave, this is a good one for you. But you gave some good information on growth numbers by segment. Maybe -- I don't know if you would look at it this way, but excluding transactional revenue what was kind of the core growth of the non-transactional business?

Yes, Charlie, we don't break it out quite that way. I think we said the transactional revenue was up about 30%. So, a little bit higher in transactional than the overall Company average growth which was 11.9% organically. So that drove a little bit more than the rest of the Company. But I think, as we pointed out, we had growth in both International segments as well as the US. And we did see even outside of capital markets almost 10% growth in both investment markets and Language Solutions and Other.

So, the growth was really across the board. I think probably the two areas of the highest growth, the transactions at about 30%, which I just pointed out, and then Venue was 38% in the quarter coming off last year where it grew 20%. So, pretty good traction that we are seeing with the data room offering.

Great and with the data room offering, just -- that kind of segues into my next question about kind of competition out there. Do you feel like you are taking some share from your competitors? Are you -- how are you shaping up versus your competition in kind of those technology offerings and kind of the outlook with the increased spend on CapEx on kind of beefing up those technology offerings that you do have? What is your kind of longer-term view there?

Yes, Charlie, hi, it is Dan. A couple comments on that. I think if we take a step back and look at the longer trend in the business, clearly much heavier influence of technology. You see the fragmentation in the offering across all offerings and the barriers to entry into what we do have come down substantially. We believe our brand, our relationships are extremely important in a market like this and the breadth of our offering is quite helpful.

When you get to each of the individual products, so we will start with Active, or rather start with Venue, the 38% represented in our estimation some share coming over to us and that is -- if you recall back in the fourth quarter we had around 20% growth in Venue. And so, we have seemed very strong performance in Venue. We think certainly transactional market drives a bit of it. But we think we are taking some share there, continue to look at additional opportunities.

If we pivot to the compliance-based platform of ActiveDisclosure, if you go back several years ago we were losing some share on the core compliance offering; that has stabilized in the recent past. I think if you look at the quarter for this first quarter results we actually picked up a handful of clients on a net basis competitively. And then you have some influence of a shrinking public Company count when you look at M&A and delistings and things like that.

But that is why it has been so important for us to have a big push on private companies, private equity and broadening out our tools. We are, as you pointed out, putting a lot investment into ActiveDisclosure. FundSuiteArc is the global investment management platform. And we, as Dave mentioned, saw very good performance in content management and there is just a ton of regulatory change going on in the fund arena, obviously always a lot going on in healthcare and the annuity side as well.

We have put a lot of investment into FundSuiteArc, we have -- we are ready for all of the change, we are leading with discussions with our customers and have seen very strong receptivity to some of the changes we are making. And then the last one, MultiTrans, which is the platform that sits under Language Solutions that came over in an acquisition and we continue to see strong performance in Language Solutions growing what we believe with the market or slightly higher than the market.

And then one comment I would make which is outside of the tech area is just on the capital markets transaction side. As we look at share data and it's -- there is some estimation that goes into calculating share; one filing is not the same value as other filings, one deal is not the same as other deals value wise, etc. But when we look at long-term trends we are doing well there and maintaining what looks to be a pretty good share. So let me see if Tom or Dave has anything to add to that.

It is Tom, Charlie. So the only thing I would add on the data room offering and competitively is we are targeting private companies as well as public companies. I think some folks think that it is an M&A IPO tool; it is also used for private Company transfer. So 50% of the revenue in the quarter came out of private Company sales.

And then the other one is we have a partnership with eBrevia, which is an analytics tool. And we are able to sell that into the channel with the law firms, so it is not just a private equity or public Company sale, it is a private Company sale and a law firm sale. So we are getting -- we are kind of using our sales channel compared to the competition to sort of leverage our data room offering that way.

And that segues nicely into my next question which is kind of more of the tone of the capital markets and kind of your public Company creation if you offer the IPOs. And as you talk to these kind of private companies and with the tools you have, does that set you up well for potentially when they do go public again or go public for the first time?

And also [it would] be interesting in the terms of the tone of the number of filings that we have seen, it seems to be a pretty good pick up year over year especially obviously off of a very easy comp. But are you seeing that kind of trend continuing? When you talk to your customers, particularly the law firms and bankers? What is their overall view of the capital markets environment right now?

It is Tom again. So I will divide that into kind of two pieces, one being kind of our internal view on how to go to market. So we look at the lifecycle of a Company. So we start out with it being private, what offerings can we use or provide while they are private?

They may go into a sale or they may go into a public offering. And then we like to think it is cradle to grave; we even have bankruptcy offerings as well and they come back out, restructure. So we see it as a lifecycle of a company, be it private or public. So that is just one piece there.

And then the other, in terms of the macro view of the market, without question there is new issue volume that is up year over year, as Dave pointed out. We see that -- and kind of in the International market aside because of the European election happening in France and things like that, that really pretty much pipeline is filling.

Our customers and the law firms feel that there is work to continue to do. But we have been in these situations before where it is positive and then it kind of flattens out. But net-net, kind of a positive view for us going forward.

Yes, and the only thing I would add to that is just to elaborate a bit on some of Tom's points is, as Dave mentioned, we had some very nice large transactions in Q2 of last year. So the comps become tougher. Outside of that, to Tom's point, we've seen a firming up in the market, a firming up of filings activity, etc. And so, feel good about the year and our guidance and, as Dave said, Q2 is just a tougher comp for us.

Maybe you can help quantify that a little bit more in terms of what kind of the outliers were last year in Q2. Kind of on a normalized revenue basis what would have Q2 looked like last year to help kind of guide investors to where we should be setting the bar.

Yes, Charlie, so there were a handful of large transactions that from a revenue perspective in aggregate those deals were probably in the $20 million to $25 million range. And as we talked about last year, the transactional side kind of carries a disproportionately high margin relative to the total Company margin. So I think if you think about the $20 million to $25 million of those large transactions at a fairly high contribution margin, that is probably the right way to think about it.

Excellent. Thanks for answering my questions.

(Operator Instructions). Brian Nolan, JPMorgan.

I wanted to ask about capital plans for later this year. You guys have a couple tens of millions of dollars in RP basket that you have kind of in excess of the cash flow suite to the term loan. I was just wondering if you were inclined to -- were you going to pay down some of the notes outstanding or did you have other plans for cash flow?

Yes, so, we mentioned on the last call and again here that from a cash flow perspective we can get to the top end of our targeted leverage range based on the full-year guidance. The priority at this point would be for debt repayment which would come on the term loan.

While the notes carry the higher interest rates they are not callable. And so, from a kind of ease of transaction and as a practical matter of repaying debt, the term loan would be the mechanism to do it.

They are not callable but could you do them in the open market?

Yes, we could do that, yes.

Is that the plan or do you -- is it really just focused on the (multiple speakers)?

Yes, we wouldn't talk about the specific plans.

Got it. Okay, thank you.

Bill Mastoris, Robert W Baird & Company.

I wondered, Dan and Dave, if you could give us a general overview of the differences that you expect in revenues and EBITDA as many end-users shift to digital from print and what impact that might have. And if you can drill it down to each one of your businesses that would be even better. So any color you can provide there would be greatly appreciated.

Yes, Bill, this is Dave, I will start. So roughly 40% of our revenue is print related and we have seen from a secular perspective that has been declining at roughly 4%. As we look at the different parts of the businesses and I will break it out -- I think start with investment markets, which is roughly 60% of the revenue in that reporting unit is print related.

As we have seen that decline we have been able to manage the profitability on a gross dollar basis. So as things shift from print and mail distribution to more content management and electronic distribution that we are able, on a lower revenue base, able to preserve similar profit dollars therefore obviously driving margin up.

So assuming that that trend continues at a reasonable pace kind of similar to what we have seen historically, we feel we can kind of continue to manage to protect the profit dollars. Obviously if it changed overnight that would be a different story.

But so far really the value we bring is around managing the content, preparing the content for distribution and doing the distribution regardless of the format. And that is really what we are getting paid for and therefore that is where the profit dollars sit.

Similar on capital markets side, but I think what we have dug deeper on is on the investment market side and that seems to be the case at least to this point.

Yes, the one thing I would add to that -- it's Dan -- is we manage our platform and we don't produce all of our own printing. We use, as has always been the case, some outside sources. So we are able to moderate and keep our facilities busy and really variableize the cost structure.

And that is how we achieve what Dave mentioned there in terms of maintaining profit dollars in an environment where volume may be trending down. And it has been -- as David pointed out, it has been pretty consistent trend. And so, just to make sure we address your question to see if there was anything else tied to that.

Not tied to that, but I do have a follow-up and this is a little bit separate. I know that you are targeting 2 3/4 as far as a yearend leverage ratio. Does not incorporate any possible M&A activity? And if there is going to be any M&A activity could we expect it to be of a bolt-on nature? Or is there any large elephant out there that would seem to be attractive?

Yes, sure. So our target is an organic target. Having said that, as you have seen what we did back at RR Donnelley, is we were very measured and we used the leverage targets as guard rails from a consideration perspective on M&A and these are long-term targets relative to what we think -- where we think we should operate within.

Having said that, we are also cognizant that the business has some cyclicality tied to it. So in a great transactions market, a certain leverage ratio is actually going to be lower than it would be in a more challenged transactions market given the same amount of debt.

In regards to the M&A pipeline, since we have been out on our own we have built a very nice pipeline. There is obviously a lot of activity in the M&A markets. Wouldn't comment on any acquisition targets in particular, but a robust pipeline. But we are measured and considerate in how we deploy capital and how we manage the balance sheet.

Okay, it sounds like this is going to be of a smaller nature, would that be a fair statement?

I think the pipeline consists of targets of all different size. I think the takeaway is that we are mindful of what leverage looks like and obviously it is going to be target specific.

Thank you very much.

And we have no further questions at this time.

Great. So thank you, Erik, and thank you, everyone, for joining. And we look forward to communicating with you in the future. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, you may now disconnect.