Dye & Durham Ltd
TSX:DND
Earnings Call Analysis
Q2-2024 Analysis
Dye & Durham Ltd
The company has displayed an appreciable performance in a generally weak quarter, with revenue climbing up by 17% despite the TM divestiture. The admissions regarding annual contracted revenue, at $203 million, accounting for 49% of total revenue, and Annual Recurring Revenue (ARR) at $112 million (27% of total revenue), underscore a transition towards a more stable and predictable revenue model. The legal technology market, valued at $25 billion in 2023, is anticipated to grow to $46 billion by 2030, placing the company in a favorable position with its suite of practice management and data insights solutions.
The launch of the Unity Global platform intends to streamline the customer experience, improve law firms' operational efficiency, and expand the company's competitive advantage. By reducing administrative burdens, law firms can focus more on client services and business growth. The company's focus on diversifying away from reliance on real estate transactions to more stable sources of revenue is critical; real estate transactions now represent 44% of global revenue, reduced from 54% in the previous year, with a target to reach 33% within the next three years.
The company's strategic financial maneuvers—specifically, the restructuring of convertible debt and completion of a substantial equity issue—have fortified its balance sheet and provided more flexibility in future operations. These actions also align with the objective of reducing the leverage ratio below 4x net debt to adjusted EBITDA and reflect a serious commitment to improving the capital structure.
With an adjusted EBITDA of $60 million, up 9% from the previous year, and strong maintenance of EBITDA margins at 54.5%, the company's operational efficiency seems robust. In addition, a significant part of the 17% revenue growth, excluding TM Group, is attributed to successful upselling strategies, optimization of pricing structures, and other efforts to integrate and maximize value from acquired businesses.
The leadership remains committed to increasing annual recurring revenue (ARR) by 15% over the next 2.5 years and anticipates further improvements in the next quarter due to initiatives that have only partially impacted the current quarter's finances. The company is also exploring various strategies to further reduce its debt and lower interest expenses, which will be beneficial for the company and its shareholders alike.
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Good morning. My name is Lara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dye & Durham Second Quarter Fiscal 2024 Earnings Call.
I would now like to turn the call over to Huss Hirji, VP Investor Relations of Dye & Durham. Mr. Hirji, you may begin your conference.
Thank you, Lara, and good morning. Welcome to the Dye & Durham conference call. Before we start, we'd like to remind you that all amounts discussed on this call are denominated in Canadian dollars, unless otherwise indicated. Please note that statements made during this call may include forward-looking statements and information and future-oriented financial information regarding Dye & Durham and its business and disclosure regarding possible events, conditions or results that are based on information currently available to management, which indicate management's expectation of future growth, results of operations, business performance and business prospects as well as opportunities.
Such statements made are made as of this date hereof, and Dye & Durham assumes no obligation to update or revise them to reflect events, disclosures or circumstances, except as required by applicable securities laws. Such statements involve significant risks and uncertainties and are not a guarantee of future performance or results. A number of these risks or uncertainties could cause results to differ materially from the results discussed today.
Given these risks and uncertainties, one should not place undue reliance on these statements and information. Please refer to the forward-looking statements and information and future-oriented financial information section of our public filings, without limitation, our MD&A in our earnings press release issued today for additional information. Joining us on the call today are Matt Proud, Dye & Durham, Chief Executive Officer; and Frank Di Liso, Dye & Durham's Chief Financial Officer. A question-and-answer session will follow the formal remarks for research analysts.
I will now turn the call over to Matt for opening remarks. Matt?
Thanks, Huss, and good morning, everybody. The business performed really well in what is typically a seasonally low quarter. We're up 17% in revenue, taking into account the impact from the TM divestiture. We continue to grow our contracted revenue. Annual contracted revenue was $203 million or 49% of total revenue as of December 31, 2023.
Contracted revenue consists of ARR, which was $112 million as of December 31, again, representing 27% of our revenue and other rep contracted revenue from contracts, overages or service agreements, which was $93 million. We're building a business of scale, delivering mission-critical software to law firms and financial institutions. The legal technology vertical was a $25 billion market in 2023 and is estimated to grow to be $46 billion in 2030. This is according to third-party reports.
Our practice management and data insights and due diligence solutions address the market's fastest-growing needs. As such, we're well positioned to win in this market. Our practice management solutions help small- and medium-sized law firms manage and grow their practices with key applications like case in matter management as well as core business functions like accounting, billing, client onboarding, workflow management and document management.
Earlier this month, we announced the launch of our Unity Global platform. We initially launched this in the U.K. and expect to launch later in Australia and Canada, that's later this year. We built the business through acquisition. We have a very large customer base with multiple core product offerings in each of our markets. These offerings solve law firm's needs, which are critical for their business and customers.
Building through acquisition means you don't necessarily have a uniform platform for clients to use across functions. The U.S. is also different. The customer experience is different. It's more difficult to leverage the brand across different applications as well. The Unity Global platform solves this. It solves these challenges by bringing together all the acquisitions we've compiled in one seamless way for our customers. It was a big project for us, and the team delivered in a very big way. The Unity Global platform makes it more streamlined for customers to access a range of products and services in one location with one login, you get access to everything you need to manage your practice.
Law firms may reduce their administrative burden and reclaim time to earn fee dedicated to client services and in turn, grow their business faster with less effort. Our competitors don't offer the same capabilities across comprehensive applications that we offer. For instance, the Unity Global platform includes a fully integrated client onboarding solution allowing law firms to quickly get binding engagement letters signed by their customers, and at the same time, allows them to seamlessly take their customers through the digital ID verification, KYC and AML process.
We believe the world-class capabilities of the Unity Global platform position us effectively to compete and continue to win market share. By offering a single global platform for a central industry-leading software solutions, we're positioned more strongly than we ever have been to lead in the global technology industry. At the same time, we're designing, building and launching new platforms. We've also taken a series of important steps as part of our larger plan to strengthen the business.
First, we strengthened our balance sheet and restructured a large portion of our convertible -- convertible debt, which taken together have significantly improved our capital structure and provides us greater flexibility. Specifically, since our last call, we increased and completed the $160 million substantial issuer bid for the 2026 [indiscernible] debentures. There is now $185 million left in principal amount outstanding on the 2026 compared to $345 million at the time of our last call.
We also issued $140 million in new debentures due November 1, 2028. These new debentures do not have the same accelerated maturity as the 2026 convertibles. In effect, we termed out $160 million for an increased yield to maturity of 2.4%. Additionally, earlier this month, we raised $145 million in cash through an equity bought deal. A capital raise places us in a stronger position with more optionality in the method -- in the method we used to continue to deleverage.
We are committed to driving our leverage ratio below 4x net debt to adjusted EBITDA, including the converts as quickly as possible. The business is stronger today as a result of these transactions. During the second quarter, we also launched a strategic review of our noncore assets to [ expedite ] our priority to deleverage. The review is examining a variety of options and is ongoing. I'm required to say that no assurances can be made that, that strategic review will result in any specific transactions or additional actions. But I assure you, we're committed to the process and we'll continue to work through the review to identify and close on the best outcome for our shareholders. Free cash flow performance and cash flow conversion are priorities of the business. In 2024 and beyond, last quarter, we announced a plan to target $70 million or more of free cash flow performance improvement by the end of Q3 fiscal '24 compared to Q1 fiscal '24.
We're on track to meet this target with a $40 million improvement on an annualized basis in Q2. This improvement was primarily due to price optimization, a reduction in CapEx and improvement in restructuring other costs and lowering adjusted operating costs. We've made material progress in diversifying the business over the past 24 months. We're a legal technology company that supports law firms to manage and grow their practices faster with less effort. We're not a real estate company.
Our exposure to Canadian real estate continues to shrink and [ mailstands ] at just 19% of total revenue. And we have even less exposure than that to resale transactions when you take into account refinancings. Put in perspective, some software companies have customer concentration that's higher than that figure. Revenue driven by global real estate transactions that law firms are working on was 44% in the quarter. That's great progress towards our goal to drive that figure down to 33% of total revenue within 3 years.
I also want to take a second to talk about on Board refresh. We added 2 new directors at the end of last year, Colleen Moorehead and Peter Brimm, and we're excited to have them on board and to bring their capabilities and skill sets with them. I'd also like to say thank you to Mario Di Pietro, who served on the Board for many years, and we wish Mario all the luck in the future ventures.
The business is in a great position today with the launch of the global Unity platform, a more diversified revenue base, a strong and growing base of ARR, a strong balance sheet and an improved capital structure. I'll now turn it over to Frank to discuss the financials.
Thank you, Matt, and good morning, everyone. This morning, we reported our second quarter fiscal 2024 results. Our results continue to demonstrate the resiliency and diversification of the business. As Matt mentioned, we continue to diversify our revenue base and enhance our practice management offering, continue to reduce our reliance on real estate transactions and increase our annual recurring revenue primarily through our practice management solutions.
This quarter, we've included a new metric, annual contracted revenue, which further demonstrates the consistency of the business. Revenues close to real estate transactions globally in Q2 was 44% compared to 54% in the same period of fiscal '23. While revenue exposed to real estate transaction in Canada was only 19% compared to 30% in the same period of last year.
Keep in mind that a portion of our 19% exposure in Canada includes refinancing transactions, when excluded, would further reduce this metric. Any recurring revenue contracted was 27% as of December 31, 2023, compared to just 16% at the same point last year. There are components of our revenue, which we do not include in ARR, such as revenue from contracted overages and other revenues under contract with service agreements.
Annual contracted revenue in the second quarter was 49% inclusive of ARR. We reported revenue of $110 million during the second quarter, an increase of 17% compared to the same period last year and taking into consideration the sale of TM Group on August 3, 2023.
Revenue grew 3% year-over-year, including the impact of TM in the prior period. Keep in mind that the Q2 and Q3 periods of our fiscal year are typically the weakest from a seasonality perspective. Q4 and Q1 in that order are typically our strongest seasonal periods. We generated adjusted EBITDA of $60 million in the second quarter of fiscal 2024, an increase of 9% or $5 million compared to the same period last year and taking into consideration the selling of TM Group.
Adjusted EBITDA grew 4% or $2.4 million, including the contribution of TM Group in the prior year. The improvement is primarily a result of the growth in revenues, both organic and inorganic as well as the early impacts from our business improvement plan. We continue to maintain our strong EBITDA margins coming in at 54.5% this quarter, which is in line with our target range of 50% to 60%.
Total adjusted operating expenses, which includes direct costs, technology costs, G&A, sales and marketing, were $50.2 million for the quarter or 44.5% of revenues. We expect our ongoing operating costs to be within the 40% to 50% range of revenues. Net of the impact of expenses from our last 12 months of acquisitions and the sale of TM Group, our adjusted operating expenses for the quarter were lower by approximately $1 million from the prior year, which demonstrates the improvements from our business improvement plan announced in the previous quarter.
As we acquire assets and manage the broader business, we continually look for ways to drive cost synergies and eliminate redundancies. Net finance costs for the quarter were $49 million compared to $38.4 million in the same period of fiscal '23. The increase is mainly due to an increase in interest rates, higher debt balances as well as unfavorable noncash impacts from the change in fair value of our convertible debentures as compared to the prior period.
Acquisition, restructuring and other costs for the quarter were $5.3 million. This was a decrease from $15.6 million in the second quarter of fiscal '23, and we believe we can deliver additional improvements in this cost line item over time. We're taking actions to increase our cash flow performance in placing a greater emphasis on this measure. Our Q2 cash flow preparations was $44.6 million in the quarter, up 57% compared to the same period last year and an improvement in free cash flows of $9 million as compared to the previous quarter.
Turning to our balance sheet. Our net debt, excluding the convertible debentures stood at approximately $1.05 billion as of December 31, 2023. Subsequent to the end of the period, we increased the size of the substantial issuer bid that Matt talked about earlier and closed the equity bought deal financing, which raised net proceeds of approximately $140 million, which was partially used to retire all of the outstanding revolving facility as of December 31, 2022.
We understand the importance of reducing our leverage ratio, and we have set a clear target to reduce it below 4x total net debt to adjusted EBITDA. That said, we have sufficient resources to manage our debt levels. The business generates strong sustainable cash flows. We've built a business of scale that is mission-critical to small- and medium-sized law firms and financial institutions. Today's results and the recent actions we've taken demonstrate the consistency of the business and the opportunity in front of us.
With that, I'll turn it back to the operator for Q&A.
[Operator Instructions] We have our first question coming from the line of Robert Young from Canaccord Annuity.
First question for me would be related to the delayed draw. It looks like you drew down on that in the quarter. And then you said that you are going to use proceeds from the recent deal to pay down the revolver. Does that include the delayed draw? Or do you think of the revolver as separate? And what's the reason for the drawdown on the delayed draw.
Rob, it's Frank here. Yes, we -- as I mentioned, we didn't draw down on delayed draw. We added a separate facility as compared to the revolving credit facility. So we completely eliminated the balance of the revolving facility that was outstanding. As you recall, it was approximately $30 million at the end of December 31.
Okay. And then maybe if you could talk about the focus on deleveraging and what happens after you reach 4x leverage? And maybe if you just talk about how you view the strategy once you hit that level.
Look, Rob, I don't think our strategy has dramatically changed. The business continues to generate a lot of cash. We'd like to -- obviously having less [indiscernible] in turn also having paying less interest enables us to redeploy that cash to continue to grow. And that's what our plan is going to be.
If I just ask that it in a slightly different way. If the deleveraging goes a little faster than people expected, will you continue to focus on deleveraging? Or is that going to continue to be important? Or will you shift more to more M&A?
We'll continue to grow the business.
All right. And then maybe last question for me. You talked a little bit about ARR expansion. I think you said that you started in the U.K. and Australia last quarter. Maybe just talk about the areas of growth in the near term. That's dominated by Canada to date, but how far do you put that...
We rolled out our ARR sales effort in the U.K. And despite it being early days, we're seeing great traction from the numbers of customers taking up contracts. Again, we're going in with a cross-sell between our data and insights business and our [indiscernible] business, and it's being very well received by being early days.
Our next question comes from the line Thanos Moschopoulos from BMO Capital Markets.
It looks like you acquired credits during the quarter. Can you provide some color on that business? Is that an ARR type of business, more transaction driven? And is there a technology you can leverage in other geographies? Or is it primarily U.K. specific technology.
Yes. It's a client onboarding tool that's used today primarily in the U.K. It has large market share in that market. And we are looking to -- depending on the needs of the market, every market has different KYC needs, and they're not just kind of country needs. They're at a kind of state-by-state product by product basis.
And so we'll continue to -- we are looking at the markets where that technology can be leveraged. But when we launched the [indiscernible] platform, we already integrated and white labeled [indiscernible] the Dye & Durham solution for our many, many law firms that spend their days in [indiscernible] platform already?
Okay. And could you provide an update regarding the strategic review of the Canadian financial infrastructure business? Or is there not much you can say on that front?
I said what I'm allowed to say and don't know if I should say it at the beginning of the call, but we do remain committed to seeing where that process goes.
Fair enough. Last one from me, just given that there seems to be signs of life in property transaction volumes is in Canada. And just heading into the upcoming quarter, is it safe to assume that we should expect to see some sequential uptick in the business in both revenue and EBITDA? I mean, recognizing you don't provide guidance, but just directionally.
We sell software to law firms that's hard to come on the real estate market.
And maybe I'd just add, we do disclose the real estate exposure metric panel. So right now, it's at -- Q2 was at 19%, and that includes refinancing transactions. So as we continue to bring customers on board with minimum subscription volumes, our exposure will continue to decrease.
And Thanos, I would just reiterate like your sub-20% of your revenue today is coming from lawyers working on transactions that involve real estate in Canada. So it would dramatically diversify the business. I think I just wanted to reiterate that.
Our next question comes from the line of Kevin Krishnaratne from Scotiabank.
Just a quick question on the ARR of 27%. I think that was kind of flat from the last quarter. I mean, can you explain why that may have been the case of that within expectations? And any ways to think about targets of where that could go over the next couple of quarters?
Yes. I mean in terms of targets, Kevin, we are committed to seeing ARR grow to 15% over the next 2.5 years. So that remain committed toward that. And now that we've added a new metric on annual contracted revenue, that would always be one step higher than our ARR metric. So we have, obviously, in our results some seasonality factors that would impact ARR, which was the main reason why you'd see a flat amount quarter-to-quarter and some other revenue adjustments that were made.
Interesting on the contracted revenue, can you dig in a little bit deeper, maybe give us some examples? Are those -- how are those structured? Are they 1 year, multiyear? And any other color you can provide on that would be helpful.
Yes. Generally, our contracts are 3-year contracts. Again, they generally have a lot of [ renew ] clauses. The recent [indiscernible], we have some 1 years, so we have a couple, not many, a few 5 years. But generally, they're -- the 3-year contracts are renewed and a lot of them have price escalators built in them.
When Frank talked about overages, there is really kind of 3 types of contracted revenue we have. There's per user per month contracts over the 3 years. So you have your traditional subscription ARR contract. There is minimum spend contracts. Some people have are just take-or-pay contracts. And then we have the overages on those take-or-pay contracts if they go over. In that other category, if I'm counting overage, we also have contracts where we are suppliers, particularly for big banks, we offer a service, often exclusively or exclusive like.
So we provide them their behalf, and we often charge transactionally for those services that we provide in the contract. So that's what we can cap here in the other bucket.
Got it. Okay. So that would be the payments [ TELUS ] financial sort of business would be kind of captured in there?
Yes. Australia, we do same things for banks. So it's a combination of those supplier contracts we have for banks and the overages on our minimum spend contracts. Those 10 month buckets where we count as other.
Got it. Okay. Cool. The last one for me. If I try to think about free cash flow, and I take your EBITDA, add it up, the interest, cash tax, working capital, I think, was softer again in the quarter. You get close to sort of flat on that basis. But as we look forward, I know you said CapEx. What are some of the other drivers that give you the confidence in the sort of like underlying free cash flow growth, I guess how do we see working capital normalizing in the next few quarters?
Yes. So I mean, you have got the main drivers correct, Kevin. So working capital, there were some silver facts from sale of TM that would have continued on into Q2. So there was a slight hurt there on the working capital side. But as Matt mentioned in his opening remarks, pricing optimization, continued reduction of CapEx, where we've only started that.
We should expect more in Q3 as well as a continued reduction in our onetime charges. And as we continue to integrate the businesses that we acquired over the last 18 months is for the opportunities for integration.
Our next question comes from the line of Scott Fletcher from CIBC.
I'm wondering if you could give us some color on how much of the 17% growth ex TM. If you could sort of break it into how much was from pricing versus contribution from M&A versus customer expansion. I understand you probably can't share numbers, but if there's any sort of directional buckets you could share, that would be helpful.
Yes. So the 17%, as you correctly pointed out, Scott, it does exclude TM. We don't disclose in organic [indiscernible] and the simple reason is when we acquire companies, we don't -- we don't keep the status quo. We will look at their pricing model. We will upsell their customers to our products. And so the vast majority of the growth that you're seeing year-over-year is that effort of upselling customers, putting them into contracts, optimizing the pricing structure and that's what [indiscernible] and there were some increases in our Canadian financial institution services as well as our data Insight products in Canada have also performed well year-over-year.
Okay. And out of those, there was -- you had spoken about pricing increases coming through in the quarter across a number of the pieces of the business. Were those fully reflected in the quarter? Or is there -- was there anything that might hit more in Q3?
Yes, some of them were fully reflected in the quarter, but there were other elements that, Scott, that we introduced in the middle of November in which case, you only see 1.5 months impact in Q2. So there will be some more [indiscernible] impact when you look at it on a full quarter basis, which will be Q3.
Okay. Then I just wanted to ask one question on the remaining 2026 converts that are outstanding. I think we all understand that there's an intention to have deal with those. What -- would another buyback take a similar shape if you were to take that approach? Would it be sort of a refinancing an additional issuance? Or does the equity raise change the calculus there, just potentially more cash consideration?
It could be a few ways to deal with it. I mean, hypothetically, you could do what you said, you could offer to buy them back either through a combination of cash or [indiscernible] offering to new converted assets.
Our leverage levels are also potentially getting to the level we could refinance our debt, see maybe they'll refinance to a credit facility, we do not have a springing maturity. But you could leave it outstanding or also buy it back. So we're exploring all options. We take deleveraging seriously. We take having a lower cost of capital seriously. One of the best ways to build value is to have the lowest cost of capital possible.
To have the most cash we can have in the business. And one of our biggest expense lines or our biggest is interest payment today. So to the extent we can reduce that, that's good for the company, good for the equity holders, good for business.
There are no further questions at this time. I'd now like to turn the call back over to Mr. Huss Hirji for final closing comments.
Thanks to all for attending, and we look forward to connecting with you during the Q3 results call in May. Have a great day.
Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.