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Good morning, and welcome to the DFIN Second Quarter Earnings Call. My name is Brandon, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded.
And I will now turn it over to Justin Ritchie, Head of Investor Relations. You may begin, sir.
Thank you, Brandon. Good morning, everyone, and thank you for joining the Donnelley Financial Solutions second quarter 2019 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 dfinsolutions.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 statements included in our earnings release and further details 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 financial information 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 financial information and a reconciliation of GAAP to non-GAAP financial information.
I’m joined this morning by Dan Leib, Dave Gardella, Kami Turner and Tom Juhase.
I will now turn the call over to Dan.
Thank you, Justin, and good morning, everyone. On today’s call, I will provide an update on our second quarter performance, as well as detail various operating highlights from across the business. Following my comments, Dave will provide additional detail on our second quarter financial results, as well as our outlook for the second-half of the year. We will then open it up for Q&A.
We reported solid second quarter results with consolidated net sales of $258.9 million and a non-GAAP adjusted EBITDA margin of 21.7%, which were both largely in line with our expectations, showing significant improvement in the trend from the first quarter, where transactional activity was heavily impacted by the U.S. government shutdown.
The software M&A environment that we mentioned on the last earnings call continue to impact transactional and Venue sales in the quarter. However, sales growth in investment markets and elsewhere in our SaaS portfolio, combined with our continued focus on controlling costs, kept margins essentially flat year-over-year.
Operating cash flow for the quarter was largely consistent with the second quarter of 2018, and total debt is down $67.2 million from the second quarter of last year, reflecting our continued commitment to deleveraging the business.
Looking deeper into our second quarter transactional performance, we capitalized on the influx of IPO activity in the market, increasing the number of priced U.S. IPOs that we completed by 33% compared to the second quarter of 2018. We supported many of the highest profile IPO listings.
Switching to M&A. Global market activity continued to fall short of last year. As a result, the number of second quarter U.S. M&A transactions we completed was down significantly. The net sales impact of the lower level of M&A activity was compounded by a cluster of larger M&A deals in the second quarter of last year.
After a very difficult fourth quarter of 2018, transactional sales from debt offerings started to rebound in the first quarter of this year and improved again this quarter, though, we’re slightly below the second quarter of 2018.
Regarding our transactional sales pipeline, we are encouraged by the activity levels we are seeing in our forecast, with increased numbers of deals on track to be completed in all key categories over the remainder of the year. IPOs should continue to lead the way accompanied by an expected improvement in M&A.
Focusing on SaaS net sales, growth was 4.1% in the quarter, accounting for 18.6% of second quarter net sales. SaaS net sales growth was led by ActiveDisclosure at 11.4%, driven by continued strong customer adoption.
During the quarter, we won new logos at a faster pace than earlier in the year, including net new competitive wins. We believe that there’s additional net sales growth upside for ActiveDisclosure in the second-half of 2019, as there’s often a lag between adding a customer and the start of revenue recognition due to new clients signing up in advance of switching to our platform.
Sales of our Venue data room, our largest SaaS offering in terms of revenue, were again below trend, largely due to lower overall M&A activity. Activity in private equity, one of our key market segments, has been particularly light so far this year, and has impacted the number of new rooms opened.
As I mentioned a few moments ago, transactional activity is forecasted to pick up, which should help to improve Venue sales growth in the second-half of the year. Overall, we anticipate an improvement in the trend of our SaaS revenue growth down from our longer-term trend, but much stronger than we experienced in the first-half.
From an overall mix perspective, services were down 240 basis points as a percentage of total second quarter net sales, as continued higher-margin SaaS growth was more than offset by lower overall capital markets transactional net sales, along with continued year-over-year growth in investment markets mutual fund product net sales. The result was a slightly less favorable mix compared to the second quarter of 2018, ultimately leading to a 60 basis point decline in gross margin in the quarter versus the prior year.
Looking ahead to the second-half of the year, we anticipate that gross margin will start to show year-over-year improvement due to the impact of the sale of the Language Solutions business, our cost savings initiatives and an increasingly favorable mix, featuring proportionally more transactional and SaaS sales relative to the mix we’ve seen in the first-half of the year.
Moving now to operating highlights. In Investment Markets, in addition to the continued demand we’re seeing for our mutual fund proxy and regulatory compliance solutions, we continue to add new business with our FundSuiteArc product suite. We’re optimizing the product suite to ensure our clients are prepared for new, more complex and more data-intensive SEC regulations.
In the quarter, we helped our clients complete the first ever successful submission of the new Form N-PORT with the SEC using our filing solution. And we’re pleased to share that all our investment market clients successfully completed the new Form N-PORT ahead of the May 30th deadline.
Our successful completion rate of both N-CEN filings last September and N-PORT this spring is testament to our commitment to provide the most accurate, secure and efficient technology to our clients.
Finally, on June 19, we held our 15th Annual FundSuiteArc User Conference in New York. One source of confidence was the theme this year. Clients had the opportunity to just learn about the latest FundSuiteArc developments, including a new AI-driven model called [Fund to Analyzer] [ph] that helps analyze clients’ funds faster for faster onboarding. In capital markets, the quarter was highlighted by a rebound in quarterly U.S. IPO net sales, with DFIN supporting a larger share of the higher-profile transactions.
Our relationships in the industry, coupled with our unique value proposition of full-service solutions from a secured data room and AI capabilities to composition, and industry-leading expertise make us a leader in the market.
We continue to invest in our solutions and recently launched a new experience for Venue clients with an intuitive design, up to 30% faster uploads and calendar view tracking of reports, data and insights, powered by the integration of Venue and eBrevia.
eBrevia continues to accelerate, providing a significant contribution to our overall SaaS growth in the quarter. eBrevia’s integration with Venue has been used on the large global law firm projects to assist with the storage and analysis of contracts, such as the processing and retention of 10,000 leases. The company is increasingly seeing interest in joint proposals in the corporate space as well, where eBrevia will provide the analysis with Venue acting as a repository for documents.
Our eBrevia customer base is diversifying and now includes corporate legal departments, law firms, audit consulting firms, financial institutions, commercial real estate firms and legal process outsourcers. ActiveDisclosure also had a solid quarter with sales growing double digits, while again, adding dozens of net new clients.
What makes ActiveDisclosure and DFIN different and what clients appreciate is that, we allow them the flexibility to choose how they work with us, providing a combination of software and/or services to meet their needs.
With that, I will turn it over to Dave.
Thank you, Dan, and good morning, everyone. Before I discuss our second quarter financial performance, I’d like to recap a significant item in the quarter that impacts our year-over-year comparability.
As we’ve discussed on the last few earnings calls, we completed the sale of our Language Solutions business in the third quarter of 2018. Our second quarter 2019 results exclude Language Solutions, while the second quarter of 2018 includes Language Solutions for the entire quarter.
As I indicated on our last call, the sale negatively impacted our second quarter reported net sales comparison by $19.8 million and negatively impacted our gross profit and non-GAAP adjusted EBITDA comparisons by approximately $5.3 million and $1.5 million, respectively, inclusive of net stranded costs.
Keeping this in mind, I’ll review the second quarter results. On a consolidated basis, net sales for the second quarter were $258.9 million, a decrease of $31.7 million, or 10.9% from the second quarter of 2018, primarily due to the sale of the Language Solutions business, along with lower U.S. capital markets transactional and compliance activity.
After adjusting for the sale of Language Solutions, changes in foreign exchange rates and the acquisition of eBrevia, organic net sales decreased 4%. The decrease was largely driven by U.S. capital markets transactional net sales, as a strong IPO quarter was more than offset by fewer M&A deals being completed when compared to the second quarter of 2018, resulting in U.S. capital markets transactional net sales being down from the second quarter of 2018.
The second quarter of 2018 also included a single multimillion dollar M&A deal, and the same deal had a similar impact on the third quarter 2018 transactional sales, which I will touch on again when I discuss our third quarter outlook.
U.S. capital markets compliance net sales were down year-over-year, as we recognize more compliance sales in the first quarter of this year, due to earlier completion of recurring work.
The second quarter declines were partially offset by continued growth in our SaaS offerings, led by ActiveDisclosure, combined with strong demand for proxy and regulatory compliance solutions in U.S. investment markets and increased transactional activity in Asia.
As Dan highlighted, our second quarter gross margin was 42.4%, or 60 basis points lower than the second quarter of 2018, primarily driven by an unfavorable mix between higher-margin services, including capital markets transactional net sales and lower-margin products net sales.
Non-GAAP SG&A expense in the quarter was $53.8 million, $7.8 million lower than the second quarter of 2018. As a percentage of revenue, non-GAAP SG&A was 20.8%, down 40 basis points compared to the second quarter of 2018. The decrease in expense was primarily driven by the impact from the sale of the Language Solutions business, cost control initiatives and lower variable compensation expense related to underperformance in SaaS net sales growth relative to our internal plan.
Our second quarter non-GAAP adjusted EBITDA was $56.1 million, a decrease of $7.3 million from the second quarter of 2018, primarily driven by lower overall capital markets transactional and compliance activity, along with the sale of the Language Solutions business, partially offset by the impact of cost control initiatives and lower variable compensation expense.
As I noted earlier, the sale of the Language Solutions business negatively impacted the second quarter EBITDA comparison by approximately $1.5 million.
Turning now to our segment results. Net sales in our U.S. segment were $223.2 million in the second quarter of 2019, a decrease of 8% from last year’s second quarter. On an organic basis, after adjusting for the sale of Language Solutions and the purchase of eBrevia, net sales declined 5.6%.
Net sales in U.S. capital markets decreased 11.8% on an organic basis, due primarily to lower overall transactional and compliance activity. This was partially offset by net sales growth in U.S. investment markets, which increased 3.7% on an organic basis, primarily driven by increased demand for proxy and regulatory compliance solutions.
Non-GAAP adjusted EBITDA margin for the segment of 24.4% decreased 230 basis points from the second quarter of 2018, primarily due to lower U.S. capital markets transactional and compliance activity.
Net sales in our International segment were $35.7 million in the second quarter of 2019, a decrease of 25.8% from the second quarter of last year. On an organic basis, excluding the impact of the sale of Language Solutions and changes in foreign exchange rates, net sales in the second quarter were up 4.4% due to an increase in transactional activity in Asia.
Non-GAAP adjusted EBITDA margin for the segment was 15.1%, up 490 basis points due to the increased level of transactional activity, the sale of the Language Solutions business and the impact of cost savings initiatives.
Our second quarter 2019 non-GAAP unallocated corporate expenses, excluding depreciation and amortization, were $3.7 million, a decrease of $2.5 million from the second quarter of 2018. The decrease was primarily driven by the impact of cost savings initiatives and lower variable compensation expense.
Consolidated free cash flow in the quarter was a use of $8.1 million, $2.3 million unfavorable to the second quarter of 2018. Relative to last year’s second quarter, the higher use of cash was primarily driven by lower EBITDA, the timing of various tax payments, as well as higher capital expenditures. This was partially offset by benefit of working capital and lower interest payments related to our debt reduction.
Our controllable working capital rate, which we define as accounts receivable plus inventory less accounts payable, as a percent of our trailing three-month annualized net sales was 18.9%, up 250 basis points from the second quarter of 2018, due primarily to higher receivable balances at quarter-end.
We continue to actively work to enhance our customer collections processes and expect year-over-year trend in this ratio to improve throughout the year, ending the year at approximately 17.5%.
We ended the quarter with $419.1 million of total debt and $409.6 million of net debt, including $55.5 million drawn on our revolver and we had net available liquidity of $88.7 million.
As of June 30, 2019, our non-GAAP net leverage ratio was 3.1 times, up 0.3 times from June 2018 and up 1.1 times from year-end 2018. The increase from year-end was partially driven by normal seasonality of our cash flow, as well as lower EBITDA, resulting from decreased transactional activity in the first-half of the year. We continue to target a gross leverage ratio in the range of 2.25 times to 2.75 times and expect to be below the low-end of that range by the end of this year.
As highlighted in this morning’s press release, we are reiterating the full-year 2019 guidance that we previously provided. While there’s no change to our guidance, I will recap our expectations.
We expect 2019 total net sales to be in the range of $910 millions to $940 million, likely coming in towards the lower-end of the range, due to the year-to-date impact of a soft M&A environment on transactions and Venue.
We expect our non-GAAP adjusted EBITDA to be in the range of $145 million to $155 million, as we continue to focus on our cost control efforts to keep us on track to meeting our profit and cash flow goals.
Depreciation and amortization is expected to be $48 million; we expect interest of approximately $35 million; our full-year non-GAAP effective 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 35 million shares; and lastly, we expect capital expenditures in the range of $40 million to $45 million, with free cash flow also in the range of $40 million to $45 million.
I also want to add a quick reminder regarding the impact of Language Solutions on the next quarter. As noted in this morning’s press release, the year-over-year negative impacts in the third quarter will be $3.2 million in net sales, $1.2 million in gross profit and $0.5 million in non-GAAP adjusted EBITDA.
On a full-year basis, the sale negatively impacts the year-over-year net sales comparison by $41.8 million and negatively impacts the gross profit and non-GAAP adjusted EBITDA comparisons by approximately $12 million and $3 million, respectively, inclusive of estimated net stranded costs. These impacts are all reflected in our full-year guidance.
Regarding our outlook for next quarter. We’re expecting third quarter net sales to be in the range of $205 million to $210 million and approximately 1.7% year-over-year organic decline at the midpoint, due in part to the very large M&A transaction in last year’s third quarter that I mentioned earlier.
Regarding profitability, we expect that our non-GAAP adjusted EBITDA margin should improve slightly when compared to the third quarter of 2018, due to the sale of the Language Solutions business and the impact of our cost savings initiatives, as well as an improved sales mix.
To summarize, second quarter capital markets transactional activity, while strong in IPOs, was negatively impacted by fewer completed M&A deals compared to the prior year, including a very large deal that span both the second and third quarters of last year.
Compliance net sales were also down in the quarter, but were largely on track for the first-half. SaaS net sales growth, while remaining temporarily off-trend this quarter, was healthy in ActiveDisclosure, eBrevia and FundSuiteArc, with Venue showing signs of a rebound heading into Q3.
Going into the second-half of 2019, we built a strong transactional pipeline, prudently invested in growth opportunities, all while diligently managing costs, as such, our full-year guidance remains unchanged.
Before I turn it back to Dan, one last housekeeping item that I’d like to mention. We will be including additional net sales details, including SaaS, as well as our quarterly sales mix in our investor presentation starting this quarter. Our latest presentation, which we posted later today and updated each quarter, can be found on the investor page of our website.
And with that, I’ll turn it back to Dan.
Thank you, Dave. Our second quarter results were largely in line with what we expected. We are encouraged by the balance of results across the business and believe we have opportunity for strong performance through the remainder of the year. We remain focused on our long-term strategy, continuing to explore ways to accelerate our ability to more quickly evolve our revenue mix, diligently managing costs while keeping our clients employees and shareholders at the center of what we do.
And with that, let’s open up the line for Q&A.
Thank you. And we’ll now begin the question-and-answer session. [Operator Instructions] And from D.A. Davidson, we have Peter Heckmann. Please go ahead.
Good morning, gentlemen. Thanks for taking the question. Given the seasonality of your cash flows and your free cash flow guidance for the year, they’re at $40 million to $45 million. It seems like there’s a potential to be at or below three times net levered at the end of the year. Is that a possibility?
Yes. Pete, I think that math is correct. Yep.
Okay. And then any updated thoughts on the outlook for capital allocation now that you’re below your target? When you get to be the [all year] [ph] leverage target in terms of M&A, potentially stock repurchases, any other thoughts on capital allocation?
Sure. Yes. No, so the targets we’ve given, obviously, are the longer-term leverage range – ranges. In terms of our priority, we continue to be very active in looking at – in the M&A environment as purchasers. Clearly, we haven’t done anything since last December, when we purchased eBrevia, which we’ve been very happy with that. We did just for – to refresh everyone’s memory, we did have a minority stake in eBrevia before we purchased it.
We have not found assets that we’ve been able to transact at what we would term intrinsic or attractive value. And so we’ll continue to be diligent. We are continuing to look. In the absence of that, we have put a little bit more CapEx into the business to grow organically, as we saw from our 2019 expected capital spending.
We’ve referenced in the past, we do expect that number to come down a bit next year. And so, we understand the various ways of deploying capital. We look at them all, but want to have that balance around finding the right opportunities to help grow the business. The Board discusses the various ways of allocating capital with management at nearly every meeting.
So it’s front and center. No change in the strategy. We are on the right path in terms of driving the revenue mix shift. And so no change to announce in our capital allocation priorities.
Okay. And just one more and then I’ll get back in the queue. But in terms of, let’s say, pending regulatory developments, things that the SEC might be having an open comment period for opportunities and risks, just any major items that we should monitor over the next 18 months?
No, there’s always various – to your point or implied in your question, there’s always plenty of vitamins being discussed, but nothing we would highlight at this time.
Great. All right. Thank you very much.
Thank you.
From CJS Securities, we have Charles Strauzer. Please go ahead.
Hi, good morning.
Good morning, Charles.
Couple of things. First, Dave, can you just repeat the Q3 guidance? Because I didn’t take the last part of that, especially on the EBITDA side what you’re kind of implying there?
Yes. Sorry, I – Charlie, thanks for the question. I think I misspoke on that. So revenue expected to be in the range of $205 million to $215 million. I think I said $205 million to $210 million, $210 million is the midpoint of our range. And that implies on an organic basis down about 1.7% at the midpoint. And then from a EBITDA margin perspective, expected to be slightly improved relative to last year’s third quarter.
Got it. When you say slight improvement just, maybe 10, 20 basis points, is that right?
Yes, that’s the right ballpark.
Great. And then that implies Q4 kind of flat to slightly up revenue sequentially from Q3, is that the way to kind of think about that low-end of the range?
Yes. I think, Q4 would be the – where we see the most significant year-over-year increase. Dan noted earlier, the soft Q4 we had last year, particularly in November and December, with some of the transactional activity that really got slow at the tail end of the year.
Got it. And then just looking at your Q2 and Q3 M&A transactional activity, yes, what was the delta year-over-year in Q2 in M&A? It sounds like there’s a pretty big drop off there. Maybe we can talk about what the level of decline was year-over-year on Q2? And then you mentioned a one-time deal in Q3. Can you quantify that? And then are there other any kind of one-timer difficult comps in Q3 we should pay attention to?
Yes. And Charlie, we don’t break out M&A specifically. I think from an overall market perspective, we’ve seen some statistics out there that M&A has been down 20% or so. And so, we, obviously, as a pretty significant player in that arena, feel the impact there.
The transaction – the M&A transaction that I mentioned that impacted last year, it was about $11 million in total, roughly five of it impacting Q2 and six of it impacting Q3 of last year.
And then to your last question on anything else. The second quarter last year, we had a pretty significant Venue data room for about a $1 million that was in the – this year’s year-over-year comparison.
Got it. That obviously ties into the M&A activity being better [indiscernible] you imagine, right?
Correct. Absolutely.
Great. And then how should we model the International segment Versus U.S. segments in terms of Q3? And just anything more weighted towards the one versus the other?
Yes. I think the biggest part – the biggest swings that we’ll see in international will, again, be transactional. We noted a pretty good quarter in Asia in Q2. I think from a pipeline perspective, our commentary around transactional is pretty broad-based, not only in U.S., but also globally.
Kind of just one last thing just on the IPO side. It seem to have a pretty robust rebound in Q2. Do you feel like you’ve got your share of the business that was out there, or even took some share maybe there?
Yes. So I think you’re correct that we did see a nice market rebound. I think from a share perspective, continuing to get our fair share. And, again, as we look at the pipeline, not only from an IPO perspective, but also M&A transactions, that deals, et cetera, feel like we’re doing pretty well from a market share perspective.
Great. Thank you very much.
Thank you, Charlie.
[Operator Instructions] We’re standing by for any further questions.
Any questions, Brandon?
So far, no further questions.
Okay. And with that, thank you, everyone, for joining. We look forward to catching up in late October, early November. Thank you. Bye.
Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for joining. You may know disconnect.