Donnelley Financial Solutions Inc (DFIN) 2017 Q4 法說會逐字稿

Welcome to the Donnelley Financial Solutions Fourth Quarter 2017 Results Conference Call. My name is Jason, and I will be your operator. (Operator Instructions) Also, please note this conference is being recorded.

I will now turn the call over to your host, Dave Gardella. You may begin, sir.

Thank you, Jason. Good morning, everyone, and thank you for joining Donnelley Financial Solutions' Fourth 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'll 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 financial information. We believe the presentation of non-GAAP results provides you with useful supplementary information concerning 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 a reconciliation of GAAP to non-GAAP information.

I'm joined this morning by Dan Leib, Tom Juhase and Kami Turner. Before reviewing our results in detail, I'll turn the call over to Dan for his opening remarks. Dan?

Thank you, Dave, and good morning, everyone. Last year at this time, I communicated that we were taking steps to set up the company as a stand-alone business. The priorities included exiting the spin-related transition services agreements, implementing plans to right size the cost structure in part to fund additional investment back into the business, bringing additional talent into the organization, identifying new market opportunities and prioritizing our investment needs.

We took a thoughtful yet aggressive approach in our actions, all intended to reshape our company to become more agile and responsive and to position the company for continued long-term success.

As I look back at 2017, we have made good progress. The steps we've taken and those we will take going forward will further strengthen our position in our core offerings and help propel us down the path toward bringing a wider array of compliance and risk-based solutions to market.

Regarding our 2017 financial performance, I am pleased with our results. We reported revenue growth of 2.2%, non-GAAP adjusted EBITDA growth of $12 million or 7.4% and margin expansion of 80 basis points. I should also note that we had a cost headwind of $13.3 million in 2017 related to the combination of stand-alone cost and allocations included within our prespin 2016 results. Our year-over-year EBITDA improvements of $12 million is after covering this headwind. In addition, in 2017, we generated $63.6 million of free cash flow, reduced our debt by nearly $130 million and ended the year within our targeted leverage range.

I am equally pleased with our fourth quarter results, which Dave will review in more detail shortly. Before we go there, I'd like to highlight some of our 2017 successes. In aggregate, our SaaS-based offerings grew by 15.1% in 2017 and now represent 13.6% of our total revenue, excluding any of the service-related revenue that is tied to these offerings. We drove strong growth in all of our SaaS offerings, ActiveDisclosure, Venue and FundSuite Arc.

Total revenue from our Venue Data Room offering grew by $9.4 million or 16.9%. For the second consecutive year, Venue was recognized in 2017 as the top M&A technology by the Global M&A Network. In our Investment Markets offering, we experienced continued revenue growth in content management as clients continue to look for efficiencies in content production and workflow solutions to help reduce their costs. In addition, we successfully onboarded many of our clients and added new clients to FundSuite Arc in anticipation of the SEC's filings requirements for Forms N-CEN and N-PORT which has now been delayed to 2019. Following the rollout of and client migration to ActiveDisclosure 3 late last year, we received very good client feedback and interest.

Our worldwide Language Solutions business grew 4.7% in 2017, continuing a multiyear trend of strong revenue growth. We are pleased with the progress we are making in these recurring revenue streams. Our opportunity is in evolving the company to leverage our domain expertise, service and process knowledge to support our customers the way they want to work as they migrate further into the digital world.

With respect to our operating plans going forward, I'd like to reiterate our key priorities. We will continue to build on the sales momentum that we have created in the areas where we have seen significant growth in our recurring revenue offerings, such as our Venue Data Room, ActiveDisclosure and our content management solutions.

We will continue to invest in and make enhancements to our software as a service solutions. We expect such enhancements to be the result of a combination of organic investment, M&A and expansion of our relationships with strategic partners. We will continue to aggressively pursue transactional and compliance activity within global capital markets. Within the transactional market, we are well-positioned to capture additional revenue as market activity improves.

Last, driven by the market opportunities that we see and our strengthened financial position, we are looking to accelerate our investments in terms of both operating expense and CapEx, targeting opportunities that can drive long-term, profitable growth.

Dave will go into more detail on our 2018 guidance that incorporates this incremental investment. At the same time, we will maintain a disciplined approach to managing our cost structure and deploying capital. In 2018, we will continue to drive growth through product development and sales and marketing effectiveness in our current offerings. We've embraced design thinking and are utilizing these techniques to create more intuitive and powerful solutions that enhance the customer journey.

In addition to our work on the user experience, we are accelerating our innovation efforts, infusing our platform with the powerful emerging technologies. We are making investments in data analytics and machine learning to provide our clients with insights and to maximize efficiencies. Employee talent is critical to our success and the success of our clients. As such, we will continue to invest in our employee base in order to ensure we deliver these capabilities in a comprehensive and cohesive platform.

Let me turn it over to Dave before we open up the lines for Q&A. Dave?

Thanks, Dan. As Dan mentioned earlier, we are generally pleased with our fourth quarter results. We saw a revenue growth of 1.7%, mostly driven by improving activity within our U.S. capital markets offering. In addition, non-GAAP adjusted EBITDA of $32.9 million improved $5.2 million or almost 19% from the fourth quarter of 2016. And our non-GAAP adjusted EBITDA margin expanded by 210 basis points versus the fourth quarter of 2016, primarily driven by cost reduction initiatives we implemented in late 2016 and early 2017.

We also generated strong free cash flow in the quarter, finishing with $63.6 million of free cash flow for the full year. On a consolidated basis, net sales for the fourth quarter were $224.8 million, an increase of $3.8 million or 1.7% from the fourth quarter of 2016.

After adjusting for changes in foreign exchange rates, organic sales increased 1%, driven by the growth in our U.S. capital markets offering, which was partially offset by declines in our international segment and U.S. Investment Markets.

The revenue growth in capital markets was driven by growth in each of our transactional, compliance and Venue Data Room offerings. The international segment revenue decline was primarily due to lower transactional revenue, partially offset by growth in our Language Solutions offering.

Fourth quarter gross margin was 38.3% or 460 basis points higher than the fourth quarter of 2016, primarily driven by cost reductions we began to implement late last year. Non-GAAP SG&A expense in the quarter was $53.2 million, $6.4 million higher than the fourth quarter of 2016, primarily driven by performance-based compensation expenses. As a percentage of revenue, SG&A was 23.7% or 250 basis points higher than the fourth quarter of 2016.

Our fourth quarter non-GAAP adjusted EBITDA was $32.9 million, an increase of $5.2 million from the fourth quarter of 2016. Non-GAAP adjusted EBITDA margin in the quarter of 14.6% was 210 basis points higher than the fourth quarter of last year, primarily driven by our cost reduction actions.

Turning now to our segment results. Revenue in our U.S. segment was $189.7 million in the fourth quarter of 2017, an increase of 3.8% from last year's fourth quarter. Revenue in our capital markets reporting unit increased 9.3%, driven by growth across our transactional, compliance and Venue Data Room offerings. Language Solutions and other reported revenue growth of 6.5%, and Investment Markets revenue declined 4.1% compared to the fourth quarter of last year, primarily due to lower print-related mutual fund and health care volume, which was partially offset by growth in content management services revenue.

Non-GAAP adjusted EBITDA margin for the segment of 19.1% increased 350 basis points from the fourth quarter of 2016. The improvement in EBITDA margin was mainly driven by our cost savings actions as well as an improved mix of revenue, achieving growth in the capital markets offering and content management and revenue declines coming in the lower margin primarily print-based offerings.

Revenue in our international segment was $35.1 million in the fourth quarter of 2017, a decrease of 8.1% from the fourth quarter of last year. On an organic basis, excluding the favorable impact of changes in foreign exchange rates, revenue in the fourth quarter declined 12.3%, primarily due to lower transactional activity which was partially offset by growth in translation services within the segment.

Non-GAAP adjusted EBITDA margin for the segment of 7.4% decreased 280 basis points from the fourth quarter of 2016, primarily due to the decline in transactional activity. Our fourth quarter 2017 non-GAAP unallocated corporate expenses excluding depreciation and amortization were $6 million, an increase of $1.2 million from the fourth quarter of 2016, primarily due to higher performance-based compensation expenses, which were partially offset by a reduction in bad debt expense and cost-savings initiatives.

Consolidated free cash flow in the quarter was $49.9 million, an increase of $12.9 million from the fourth quarter of 2016. The improvement in free cash flow was driven by improved working capital management, higher EBITDA and lower capital spending, partially offset by an interest payment that we did not have in the fourth quarter of 2016 as well as higher cash taxes in the fourth quarter of 2017.

We ended the year with $458.3 million of total debt, $52 million of cash and gross leverage of 2.6x, which is within our targeted leverage range of 2.25x to 2.75x and a full turn lower than the 3.6x gross leverage we reported at year-end 2016.

Since the spin-off from R.R. Donnelley, we have reduced our total debt by $178.2 million. We recorded additional income tax expense of $22.4 million in the fourth quarter related to the impact of the U.S. Tax Cuts and Jobs Act, representing our initial estimate of the transition tax on accumulated foreign earnings and the remeasurement of net deferred tax assets. Going forward, we have the ability to move cash freely from foreign jurisdictions to the U.S. without additional tax implications.

From an operational perspective, we estimate needing, on average, a total daily cash balance of approximately $10 million, roughly $5 million in the U.S. and $5 million internationally. As I mentioned earlier, we had $52 million of cash on the balance sheet at year-end.

Before I turn it back to Dan, let me share more detail on our full year 2018 guidance that was summarized in this morning's press release. Our guidance assumes a flat capital markets transactional environment and, as noted in our press release, includes an increased level of investment in both operating expense and CapEx targeted toward driving long-term revenue growth.

We expect 2018 revenue of approximately $1 billion, representing organic growth in the range of 1% to 2%. We expect our non-GAAP adjusted EBITDA to be in the range of $165 million to $175 million.

I should note that, beginning in 2018, pension income will be reported in the P&L on the investment and other income line instead of SG&A and will be excluded from our calculation of non-GAAP adjusted EBITDA.

For reference, 2017 SG&A and non-GAAP adjusted EBITDA included pension income of $3.3 million. Depreciation and amortization is expected to be approximately $50 million. We expect interest expense of approximately $37 million. Our full year non-GAAP tax rate is expected to be in the range of 29% to 31%. We project the full year fully diluted weighted average share count to be approximately 34 million shares, and lastly, we expect capital expenditures in the range of $40 million to $45 million and free cash flow in the range of $55 million to $60 million. Our 2018 free cash flow guidance assumes approximately $15 million of outflows for spin-off-related cost, primarily related to systems replacements that will continue throughout 2018 and taper off in 2019.

As I noted earlier, the CapEx increase is primarily targeted towards areas where we are looking to accelerate long-term growth. Regarding timing and seasonality, we expect the first quarter to have a difficult year-over-year comparison, primarily in the investment markets reporting unit, as the first quarter of 2017 included outsized revenue from 2 mutual funds special proxies which will not repeat this year.

And with that, I'll turn it back to Dan.

Thank you, Dave. Before we open up the line for Q&A, I want to reiterate the progress we've made in our first full year as a stand-alone company. We've identified potential growth opportunities, where we can leverage our core capabilities and client relationships to serve new markets and plan to accelerate our investments to capitalize on these opportunities.

We are planning to host an Investor Day in New York late in the second quarter, during which we will discuss these opportunities in more detail. Additional details on that event will be available in the coming weeks, and we hope to see you there. And with that, let's open up the line for Q&A.

(Operator Instructions) And our first question comes from Charles Strauzer from CJS Securities.

A couple of questions. Let's start off with Q4 on the Investment Markets. You've mentioned that the lower print-related mutual fund health care revenue was kind of the culprit why the -- that segment was down 4-plus percent there. If you kind of strip out the print from the recurring revenue portion, can you give us a little more color on how that portion -- the recovering revenue portion grew, excluding print?

Yes, so I think the -- thanks for the question, Charlie. As we said, a lot of that was the print-driven, mostly on the health care side. I think when you look at some of the content management services, was about, I think, 8% for the quarter, and which is pretty similar to the growth that we had for the year. I think it was around 8% or 9%.

Got it. Great. And then if you look at, kind of, the increased CapEx and other things, can you just quantify what the delta is there? It looks like you've, kind of, taken the tax savings and plowing that right back into the investments in the companies. Is that correct?

Yes, that -- yes, that's correct. So taking that opportunity to invest, and it's mostly around our external-facing products to drive additional growth. And then we also mentioned some of the innovation areas that we're looking to start the fund. And all of these things ultimately end up in a ROI type of model, prior to getting extensive funding, but we are seeding a few different initiatives, but the majority of the funding is related to the external-facing products, the SaaS-based offerings.

And should we think about the kind of $40 million to $45 million number to be kind of a new kind of constant maintenance number going forward? Or is this some onetime things here and there?

Yes, Charlie, good question. I think -- so as we've done work for the last year looking at the opportunities ahead and where some of the growth avenues might lie, we did identify these and had specific projects lined up. I think, look, to the extent that we can continue to do some of that work and find incremental opportunities, we'll continue to reinvest back in the business to try and drive growth. To the extent that some of those opportunities may not be there or may not be there in terms of that magnitude, as Dan said, each one of these projects, kind of, stands on their own. So we'll have a better view in the second quarter Investor Day in terms of kind of long-term guidance on CapEx but nothing specific at this point.

Next we have David Ridley-Lane from Bank of America Merrill Lynch.

Wondering about the -- in the recent bout of volatility in the stock market, what did you see in terms of IPOs getting postponed? How does that influence your view of first quarter '18 and the capital markets business?

Yes, yes. So we saw a lot of volatility that followed the market volatility in the underlying M&A activity. Did see, obviously, the tax change being quite positive to the overall M&A environment, as -- in part due to lower rates but also in part to the free flowing of capital between borders. That said, there is still a lot of activity that's taking place in the private markets, and so for us, that results in a good opportunity within our Venue business, when those end up in the public markets, it ends up in an additional opportunity for us relative to our transactional business. And did you have any additional numbers to add to it?

Yes. So I mean we did, obviously, see some market growth in IPOs in 2017. And I think it started out pretty well and then tapered off a little bit in the middle of the year, and then started to pick back up, and so I think pretty similar to what we've said on previous calls, the visibility, certainly from a long-term perspective, remains fairly limited.

Sure. And I guess on the -- your view around IPO activity for the full year, I heard you that guidance that implies kind of flat transactional activity levels. Are you more optimistic on IPOs or M&A or debt issuance?

Yes, so David, good question. I think when we look at -- and the intent of that assumption was just to, kind of, set a framework for you to understand, kind of, how we're thing on the guidance. Again, from a visibility perspective, as we saw in '17, right? I think I mentioned the IPO volume up and down then picking back up again. We saw some kind of choppiness within M&A throughout the year as well and so, in aggregate, we would just look at those big buckets of transactions being relatively flat. Obviously, if it -- if that changes and it picks up, that should point you one way relative to our guidance or if it declines, potentially toward the lower end.

All right. Then just a clarification question, really quickly. The pension income that will -- is that now running through investment and other income? Would you expect that to be at a similar magnitude to 2017?

Yes, it's like $100,000 different.

And next we have Pete Christiansen from Citi.

So I think earlier in the year, you were talking about this new cross-selling effort with SOXHUB on the compliance side in GCM. And then also you had the upgrade to Office 365. Can you give us a sense of how that has affected some sales? Are you seeing better retention? Or improved market share?

Yes, sure. So on the ActiveDisclosure front, we did see improved, as the year went on, net wins. And so if you go back several years, we were in a net deficit in terms of customer experience or customer retention, and we did see that turn around into a net win. And some of that driven by the -- an increase in IPOs, et cetera but still a positive development for us. As it relates specifically to SOXHUB, which has now been rebranded to AuditBoard, is the new name, so you may hear us refer to both company names, that's been going very well. We see a tremendous amount of market opportunity. There is faster cycle time in transacting with SOXHUB and so excited about the investment that we've made, and that has been going well.

And then, looks like we had a bit of a mix shift this year with the products going down 2% on mostly print there. Do you expect a similar dynamic in the guidance there?

Yes, I think, from a print perspective, we've seen that, kind of, a secular decline of about 4% annually. It's been pretty consistent. Obviously, some of those numbers jump around with some of this -- the onetime transactions or compliance pieces. But from a secular perspective, pretty constant at about 4% decline and no different expectation as we look at 2018.

Okay. And I think earlier this year, you were expecting $5 million to $10 million of transition CapEx. Looks like CapEx came in a little bit lower this year, was some of that pushed into next year?

Yes. So there were some, as we worked through some of the product development. Just from a timing perspective, we were looking at originally CapEx kind of in a $30 million to $35 million range. Came in just under $28 million, so I think what you're seeing in the 2018 guidance, as we kind of lock down some of those plans, some of which is shifting as well as some of the additional opportunities that Dan noted earlier.

Yes, as we've mentioned the past, roughly 75% of our capital relates to product development.

Okay, that's helpful. Last one for me. Any pending regulatory issues or initiatives that we should be mindful of this year?

Yes, so we referenced it the N-CEN, N-PORT was pushed from, what was originally a July 1 date in 2018, and pushed back about 9 months to April 1 of '19. Other than that, continue to be some proposals around 30e-3, which is the opt-in versus opt-out on mutual fund reporting. Seen some activity around there, tough to call where that lands. Ultimately, long term, we do see some shorter form documents being proposed and some interested in that, I -- tough to call the timing on when that takes place.

Next we have Andrew Steinerman from JP Morgan.

This is Andrew Steinerman for Mike Cho. Two questions. The first one, I didn't quite hear if you quantified what are incremental investment. So just the incremental investments part for 2018, the stuff you accelerated. The second question is, could you also make some comment in terms of assumptions around other segment when framing that 2018 organic revenue guide of 1% to 2% besides for flat for the capital market segment?

Yes. So -- and we didn't specifically quantify the incremental investment on the operating expense, but I think if you kind of walk through the EBITDA, so we did $174 million this year. As we mentioned, that included $3 million of pension income. So, kind of, an apples-to-apples basis, you are at $171 million. And if I just take the -- we said 1% to 2% organic revenue growth, right? So take the midpoint, call it roughly $15 million, and from an incremental profit perspective, it's a few million bucks, so say, $4 million to $5 million, so the $171 million would otherwise go to $175 million or so, and then our guide is $165 million to $175 million.

I got you, and then segment comments around the 1% to 2% framework.

Yes, so I think, we would expect to continue to see more of the same. The areas where we've seen growth is, as Dan alluded to, primarily in the software offerings, so Venue, ActiveDisclosure, which both sit within capital markets, and then on the Investment Markets side, growth in content management, and Investment Markets is more heavily weighted with some of the print revenue, and so over a longer term, that reporting unit's been relatively flat. So probably expect more of the same there, and then on the international side, Language Solutions has been growing kind of mid- to high single digits. Would expect more of the same for that offering. And then the rest of international is the transactional market, and as you noted, we are just assuming flat there.

And next we have [John Kim] from [Driehaus Capital].

Taking a look at the balance sheet here, you guys have made tremendous progress on the debt reduction front with net leverage at 2.3x and secured leverage south of a turn. It looks like there's an opportunity to reduce the cost of the debt further at your bank loan level, is that something that you are going to evaluate, as the soft call protection rolls off in April?

Yes, yes, so I think, John, as we -- as you know, we repriced that just a little while ago and shaved off 100 basis points. There is the 6-month soft call. So we're, obviously, always looking at opportunities to reduce that cost and then I think, also on the bond side, right, there's the 5-year restriction on calling that, so a little bit tougher on the bonds, but certainly from a bank loan perspective, there may be opportunity there.

And we have a follow-up question from Charles Strauzer.

Just wanted to go back to Q1 commentary, just, obviously, tough year over year comps with the 2 large proxies you mentioned. Can we get a little bit more discussion about how to think about Q1 from both a top line and EBITDA perspective? And also maybe just a little bit more commentary around how to think about the various segments?

Yes, Charlie, so there were a couple large mutual funds special proxies and again, most of that was print related, and so we are calling for the year organic revenue growth in that 1% to 2% range. Would expect Q1 from a revenue perspective to be down slightly. From an EBITDA perspective, there is a lot of puts and takes there, but I think if you look at kind of the full year guidance and spread that over the year, it should get you pretty close.

Got it. So I think -- just in terms of Q1 EBITDA year-over-year, do you expect that to be down slightly? Because I mean, obviously, the print revenues is lower margin than your other offerings.

Yes.

Yes.

Yes, so I think down slightly is not a bad assumption.

Yes, exactly.

(Operator Instructions) Next we have Jake Williams from Wells Fargo Securities.

I was hoping you could expand on the products that you're investing in. Is that are more in line with developing the existing products? Or are you looking at creating new products as well?

Right. So if you -- each of our customer-facing products, so ActiveDisclosure, we rolled out 83 late last -- or late 2017. We are making incremental investment there, and we are adding functionality to that tool. Adding some integration with some other products that we currently partner with, and that's been going very well. When you go to FundSuite Arc, we made reference last year during 2017 as well as a touched on it a bit on this call, but in preparation for the N-PORT, N-CEN rollout, and we've been in market selling that with good success, we have substantially added to that product. And the final product on Venue, again, with the success we've had there, we're investing both in the technology as well as in these -- incrementally in sales and marketing. So those would be the 3 main customer-facing pieces of software, and then we are also adding some additional investment, both capital and operating expenses, as we talked through, on some of the AI and data analytics capabilities.

And we have a follow-up question from Pete Christiansen.

Just a quick one. I realize there is some accounting changes going into effect for next year in terms of reporting operating leases on the balance sheet broadly for public companies. Is that something that could be beneficial for your offering? Or you see any opportunity with things like that?

Right. So typically with accounting changes like that, and we saw it with the 606 adoption, we do see some ability, both from thought leadership as well as some of our partners that offer solutions and then as well as in our base product to support customers. I wouldn't point to the lease accounting in isolation and point to that as a major tailwind for us. But all of those regulatory changes, as we see over time, some cut against us, some cut for us, that's one that marginally could have some benefit.

Okay, and it appears we have no further questions.

Okay. You with that, I'd like to thank everyone for joining us. Look forward to catching up in May with the first quarter results, and then as we mentioned, we'll be coming out shortly with a Investor Day details and look forward to seeing you all there. So thank you. Bye.

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