Donnelley Financial Solutions Inc

Ladies and gentlemen, thank you for standing by and welcome to the Donnelly Financial Solutions Second Quarter 2021 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mike Zhao, Head of Investor Relations. Thank you. Please go ahead, sir.

Thank you. Good morning, everyone, and thank you for joining Donnelly Financial Solutions' second quarter 2021 results conference call. This morning, we released our earnings report, a copy of which can be found in the investor section of our website at DFINSolutions.com. During this call, we'll refer to forward-looking statements that are subject to risks and uncertainties. For complete discussion, please refer to the cautionary statements included in our earnings release and further details in our most recent annual report on Form 10-K, quarterly report on Form 10-Q 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 earnings release and related tables for GAAP financial information and reconciliations of GAAP to non-GAAP financial information. This morning, I'm joined by Dan Lieb, Dave Gardella, Craig Clay, Eric Johnson, Floyd Strimling, and Kami Turner. I will now turn the call over to Dan. Thank you, Mike, and welcome to your first earnings call at DFIN. Mike recently joined DFIN from Teradata, an enterprise SaaS company, where he led finance for one of their go-to-market segments. At DFIN, Mike is heading up financial planning and analysis, as well as investor relations, working closely with Dave. We look forward to you meeting Mike. Good morning, everyone. And from all of us at DFIN, we hope that you and your families are staying safe and healthy. After a very strong start to the year in the first quarter, I am again pleased with the momentum in our second quarter operating performance, as well as within our end markets. On our last few quarterly calls, we noted that we had been seeing a return to a more normalized level of growth in software sales and a significant increase in transactional activity. The momentum in software sales accelerated in the second quarter, while the transactional environment within capital markets remains strong. Our second quarter results offer another proof point of the success of DFIN's transformation and our 44 in 24 strategy, specifically targeting 44% of our sales from software solutions by the year 2024, and more importantly, the resulting financial profile from such a business mix. For eight consecutive quarters, we have expanded year-over-year adjusted EBITDA margins as our business mix changes. This has involved investing heavily in some areas for profitable growth, aggressively managing expenses in other parts of our offerings, and eliminating some offerings altogether. Over this two-year period, on a trailing 12-month basis, our overall revenue increase of 3% or $27 million reflects our changing mix. Our revenue change is comprised of growth in software sales of $50 million or 27%, tech enabled services growth of $87 million or 23%, and a decline in print and distribution of $110 million or 32%. These are large changes over a two year period, yet they are positive changes for our business. Our software offering now totals $232 million, with roughly two thirds of that being recurring high retention rate offerings. The balance of our software offering is largely driven by the corporate transactions market. By year end, we expect our software sales to exceed our print sales for the first time in the company's history, representing approximately 30% of our total revenue. And when we talk about our 44 and 24 strategy, We note, in addition to the mix shift, what's more important is the resulting financial profile from such a business mix. Two of the resulting financial aspects are an increase in profitability and an increase in margin. Over the same two-year period, adjusted EBITDA has been up by over $100 million, driving margin up 1,000 basis points to 25%. At quarter end, our trailing four-quarter adjusted EBITDA is $233.5 million. In short, our strategy is delivering strong results. We look forward to sharing ongoing progress with you as we execute our strategy. As it relates specifically to the second quarter results, total sales grew 5.3% from last year's second quarter. Excluding print and distribution, year-over-year net sales increased 23% in the quarter as software solution sales grew 40% and tech-enabled services grew 16%, overcoming a decline of 26% in print and distribution-related sales. As a reminder, The decline in print and distribution sales is a result of the regulatory change in the investment company's business and our proactive exiting from low-margin printing contracts, consistent with our strategic priority of investing to grow the more attractive recurring software and tech-enabled services aspects of our business. The record high quarterly software solution sales was led by our recurring compliance products, which in aggregate grew 36% over the second quarter of last year. We've received positive market feedback and strong client adoption for our recent product launches, particularly in active disclosure and total compliance management, a component of our Arc Digital offering, along with Arc Pro, contributing to the 36% growth in our recurring compliance software sales. In addition, our virtual data room product venue achieved another all-time high for quarterly sales and grew approximately 50% year-over-year, largely driven by an increase in M&A deal activity and, once again, what we believe to be market share gains. Similar to the last few quarters, the strength of the capital market's transactional activity has and our strong market share resulted in robust sales growth, with transactional sales increasing more than 38% from the second quarter of 2020. The growth in higher margin software solutions and tech-enabled services net sales, our proactive pruning of low margin print work, along with the significant impact of our ongoing cost control efforts, including execution of our aggressive plan to right-size our print platform in light of the regulatory impact on print demand, again resulted in strong quarterly earnings. Second quarter non-GAAP adjusted EBITDA was $79.9 million, an increase of over 31% from last year's second quarter. An adjusted EBITDA margin was 29.9%, up 600 basis points from second quarter 2020 adjusted EBITDA margin. Given the trend I noted earlier with eight consecutive quarters of expanding year-over-year EBITDA margin, our trailing four-quarter adjusted EBITDA margin is currently 25%, tracking well ahead of our long-term target of at least 20%. As I highlighted on our last call, the steps we took during 2020 and continue to take in 2021 to optimize our operations, streamline our organizational structure and real estate footprint contributed to our second quarter growth in adjusted EBITDA and expansion of adjusted EBITDA margin. At the same time as having aggressively managed the cost structure in certain areas, we've also increased investment levels in support of our strategic priorities. Specifically, we've allocated more resources in terms of both people and dollars toward our software products and the technology that supports these products. To be clear, while we've increased investment in this area to accelerate our transformation, we've done so with the same disciplined approach we've taken historically, targeting areas and projects where we expect to deliver superior economic returns. Free cash flow in the quarter improved by $16.5 million, despite funding $15.7 million related to the LSC multi-employer pension plan obligation. Dave will cover this topic in more detail. At quarter end, our non-GAAP net debt was lower than last year's second quarter by $112.3 million, resulting in a non-GAAP net leverage of 0.9 times, 1.2 times lower than the second quarter of 2020. Before I share a few business highlights, I would like to turn the call over to Dave to provide more detail on our second quarter financial results and our outlook for the third quarter. Dave? Thank you, Dan, and good morning, everyone. As Dan noted, we delivered very strong results in the quarter, including 5.3% sales growth. and significant year-over-year increases in non-GAAP adjusted EBITDA, adjusted EBITDA margin, non-GAAP adjusted earnings per share, and free cash flow. We maintain strong market share in our transactional filing business and posted 40% growth in our software solution sales, all while continuing to drive operating efficiencies. On a consolidated basis, net sales for the quarter were $267.5 million, an increase of $13.5 million, or 5.3%, from the second quarter of 2020. Software solutions net sales in the second quarter increased by $19 million, or 39.9%, primarily due to an acceleration of virtual data room activity and venue driven by the improved M&A environment accelerated product adoption within arc suite as well as solid subscription growth in active disclosure tech enabled services net sales increased by 18.6 million dollars or 16.1 percent primarily due to increased capital markets transactional activity britain distribution revenue decreased by 24.1 million dollars or 26.5 percent primarily due to the regulatory driven reduction in demand for printed materials within investment companies and less commercial printing where we have proactively exited certain low margin contracts. This decline was partially offset by higher print related sales as a result of the increased transactional activity within capital markets. Regarding our print platform, we have made substantial changes over the past couple of years. By year-end 2021, we expect to be utilizing our third-party network for approximately 85% to 95% of our print needs, variabilizing the cost structure for the majority of our print production, and at the same time, operating our own digital-only print platform to meet the demand for higher-value, quick-turn requirements. Second quarter nine-gap gross margin was 56%. approximately 970 basis points higher than the second quarter of 2020, primarily driven by a favorable business mix featuring growth and higher margin tech-enabled services and software solution sales, combined with lower overall print volume and the impact of ongoing cost control initiatives. Non-GAAP SG&A expense in the quarter was $70 million, for $13.2 million higher than the second quarter of 2020. As a percentage of net sales, non-GAAP SG&A was 26.2%, an increase of approximately 380 basis points from the second quarter of 2020. The increase in non-GAAP SG&A is primarily due to sales commissions on higher sales, changes in the business mix, and higher incentive compensation expense, partially offset by the impact of ongoing cost control initiatives. Our second quarter non-GAAP adjusted EBITDA was $79.9 million, an increase of $19.1 million or 31.4 percent from the second quarter of 2020. Our second quarter non-GAAP adjusted EBITDA margin was 29.9 percent, an increase of approximately 600 basis points from the second quarter of 2020 Again, primarily driven by the favorable sales mix and ongoing cost control initiatives, partially offset by higher incentive compensation and selling expenses. Turning now to our second quarter segment results, net sales in our capital market software solution segment were $43.8 million, an increase of 37.7% from the second quarter of 2020, primarily due to increased venue virtual data room activity and continued growth in active disclosure subscriptions. Venue sales increased approximately 50% from the second quarter of 2020, driven by an improving M&A environment and sales and marketing efforts focused on gaining market share and accelerating growth while our recurring compliance products after disclosure in file 16 also had a solid quarter, posting 26% growth in aggregate. Non-GAAP adjusted EBITDA margin for the segment was 29%, an increase of approximately 1,260 basis points from the second quarter of 2020. The increase in non-GAAP adjusted EBITDA margin was primarily due to the increased sales, a favorable sales mix, as well as the impact of operating efficiencies partially offset by higher selling expenses as a result of the increased sales volume. Net sales in our capital markets compliance and communications management segment were $153.1 million, an increase of 26.7% from the second quarter of 2020, primarily due to increased capital market transactional activity, continuing the trend that began in the third quarter of 2020. This growth was largely driven by the ongoing momentum in IPO activity, as well as increased M&A activity, including D-SPAC transactions. Non-gap adjusted EBITDA margin for the segment was 43.4%, an increase of approximately 260 basis points from the second quarter of 2020. The increase in non-gap adjusted EBITDA margin was primarily due to the increased sales volume and a favorable sales mix. As we anticipated and also communicated on our last call, we did see a sequential decline in SPAC IPO registration activity based on the SEC statement regarding the accounting classification of warrants and their potential action on legal protection for growth projections. Second quarter sales driven by SPAC registrations were less than $400,000 compared to approximately $3.6 million in the first quarter. Over the last four quarters, we've completed 139 SPAC registrations and have generated approximately $6.2 million in sales for these transactions. As it relates to this activity, the bigger opportunity lies ahead as the value of a de-SPAC transaction is, on average, 10 times the value of the initial registration transactions. Further, these transactions provide a pipeline for recurring software subscriptions to support our clients' ongoing compliance requirements. Net sales in our investment company software solution segment were $22.8 million, an increase of 44.3% from the second quarter of 2020 to primarily due to strong demand for our ARK Digital Total Compliance Management offering in the quarter, which continues to gain momentum since we launched it in the second quarter of 2020, with new opportunity rising out of the regulatory changes affecting investment companies. In addition, growth in ARK Pro related to new subscription activity and organic growth from existing clients also fueled the growth in this segment. Non-GAAP adjusted EBITDA margin for the segment was 29.4%, an increase of approximately 600 basis points from the second quarter of 2020. The increase in non-GAAP adjusted EBITDA margin was primarily due to the increase in sales and a favorable sales mix, partially offset by higher incentive compensation expense. Net sales in our investment companies' compliance and communications management segment were $47.8 million, a decrease of $37.8 million, or 44.2% from the second quarter of 2020, due to the impact of regulatory change in investment companies affecting print-related sales and a reduction of commercial printing sales related to contracts we have proactively exited. Non-GAAP adjusted EBITDA margin for the segment was 10.9%, approximately 290 basis points lower than the second quarter of 2020. The decline in non-GAAP adjusted EBITDA margin was primarily due to the lower activity levels for print and distribution. This impact was partially offset by a reduction in overall expense within the segment. primarily due to cost savings as a result of the consolidation of the print platform and a lower allocation of overhead costs, which are now being absorbed by our other three operating segments, as the lower activity level in this segment results in a reduced need for such shared resources. Second quarter has historically been our peak quarter in terms of print activity, and with approximately 60% of the reduction in print demand now behind us, the execution of our plans to consolidate the print platform and to capture the related cost savings continue to track ahead of plan. Regarding the regulatory change that will continue to reduce demand for print in this segment, We continue to expect a reduction in print-related net sales of approximately $130 million to $140 million and a reduction in non-GAAP adjusted EBITDA of approximately $5 million to $10 million related to the regulatory change. Non-GAAP unallocated corporate expenses were $11.2 million, an increase of $2 million from the second quarter of last year. The increase in unallocated corporate costs was primarily due to increased incentive compensation driven by the strong performance, partially offset by the impact of ongoing cost control initiatives. Free cash flow in the quarter was $20.9 million, representing an improvement of $16.5 million from the second quarter of last year. As Dan mentioned earlier, this improvement was despite having funded $15.7 million related to the LSC multi-employer pension plan obligation, the vast majority of which was related to lump sum settlement payments with two of the three plans. Last year's second quarter did not include any payments related to this item as we began making payments in the third quarter of 2020 So the full $15.7 million cash outflow was incremental to last year's second quarter. As a reminder, DFIN and RR Donnelly agreed to share required payments equally, and an adjustment and repayment will be made as needed in accordance with the final allocation determined in arbitration, which we expect to occur before the end of the year. We ended the second quarter with $240.9 million of total debt and $201 million of non-GAF net debt, including $10 million drawn on our revolver. From a liquidity perspective, we had access to the remaining $287.7 million of our revolver, as well as $39.9 million of cash on hand. As of June 30, 2021, our non-GAAP net leverage ratio was 0.9 times, down 1.2 times from the second quarter last year. Our cash flow is historically seasonal. We are a user of cash in the first half and generate more than 100% of our free cash flow in the second half of the year. As our sales mix continues to evolve to proportionally more subscription-based software solutions, we expect the seasonality to be less significant. During the quarter, we amended and extended our credit agreement to, among other things, provide for a $200 million delayed draw term loan aid facility and to extend the maturity of the $300 million revolving facility to May 27, 2026. The proceeds of the term loan may only be used to redeem or repurchase the company's eight and a quarter percent senior notes due 2024, which become redeemable on or after October 15th, 2021. It is our intent to redeem these notes at that time, which following that transaction will lower our annual interest expense by approximately $14 million. The company repurchased approximately 251,000 shares of common stock during the quarter for $7.1 million at an average price of $28.19 per share. We have approximately $39.6 million remaining on our $50 million stock repurchase authorization. As it relates to the third quarter, transactional activity in capital markets remained robust throughout July. Regarding our outlook for the quarter, we are expecting consolidated net sales to be in the range of $200 million to $210 million, down approximately $5 million or 2.5% year-over-year at the midpoint due to the planned reduction in print and distribution for the regulatory changes related to SEC Rules 30E3 and 498A. Excluding print and distribution, third quarter revenue is estimated to grow by approximately 14% at the midpoint of our range. We remain bullish on the near-term outlook for our software solution sales, as well as on capital markets transactional activity. From a profitability perspective in the third quarter, we expect a non-GAAP-adjusted EBITDA margin in the low to mid-20% range, similar to last year's third quarter margins. With that, I'll now pass it back to Dan. Dan? Thanks, Dave. The execution of our strategy continues to deliver positive results. Our new software offerings continue to attract strong interest and adoption. The momentum in software combined with our strong position in the transactional market has enabled us to generate sustained sales growth over the last four quarters. In addition, We have now delivered year-over-year expansion in EBITDA margins for eight consecutive quarters, demonstrating the continued improvement in our business mix and disciplined cost management, while also increasing investments to accelerate our strategy. The trends in our top and bottom line results reinforce the value of our 44 and 24 strategies. Achieving this goal is driven by increases in our software solutions and tech enabled services sales and decreases in print sales, yielding strong margins and cash generation. In closing, we're excited about our very strong first half of the year and remain keenly focused on driving our 44 and 24 strategy. The adoption trends for our new software products and our various operational successes illustrate the exceptional value we are delivering to our clients. We continue to find and focus on opportunities to further enhance shareholder returns. Before we open it up for Q&A, I'd like to thank the DFIN employees around the world who have been working tirelessly to develop new products, maintain our operations, and ensure our clients continue to receive the highest quality service without disruption. Stay safe and healthy. Now with that, operator, we're ready for questions.

At this time, if you have a question, please press star to the number one on your telephone keypad. And your first question comes from Charlie Strasser with CJS.