Donnelley Financial Solutions, Inc. (NYSE:DFIN) Q1 2024 Earnings Call Transcript May 1, 2024
Donnelley Financial Solutions, Inc. beats earnings expectations. Reported EPS is $0.91, expectations were $0.82. DFIN isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. My name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donnelley Financial Solutions’ First Quarter 2024 2023 Earnings Conference Call. [Operator Instructions] I would like to turn the call over to Mike Zhao, Head of Investor Relations. Please go ahead.
Mike Zhao: Thank you. Good morning, everyone, and thank you for joining Donnelley Financial Solutions’ first quarter 2024 results conference call. This morning, we released our earnings report, supplemental trending schedules of historical results, copies 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 risks and uncertainties. For a complete discussion, please refer to the cautionary statements included in our earnings release and further detailed 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 certain non-GAAP financial information such as adjusted EBITDA, adjusted EBITDA margin and organic net sales.
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. I am joined this morning by Dan Leib, Dave Gardella, Craig Clay, Eric Johnson, Floyd Strimling and Kami Turner. I will now turn the call over to Dan.
Dan Leib: Thank you, Mike, and good morning, everyone. We started 2024 by building on the positive momentum in our performance from last year, delivering consolidated organic net sales growth with an improved sales mix, strong year-over-year growth in adjusted EBITDA, adjusted EBITDA margin expansion, and improvements in both operating cash flow and free cash flow. We delivered first quarter net sales of $203.4 million, which increased 2.8% on an organic basis compared to the first quarter of 2023. I am encouraged by the composition of our organic net sales growth. With Software solutions net sales increasing 16%, Tech-enabled services net sales increasing nearly 6% and Print and Distribution net sales declining approximately 20% as we continue to balance our revenue profile to drive improved profitability.
The combination of the improved revenue profile, modest consolidated net sales growth, and cost management yielded first quarter adjusted EBITDA of $55.2 million, and adjusted EBITDA margin of 27.1%, both of which are above last year’s first quarter, and once again significantly stronger than historical periods with similar revenue profiles. Our first quarter performance highlights the continued progress we are making in our transformation and positions us well to achieve our updated long-term financial targets. A key driver of our first quarter results is the performance of our software solutions portfolio, which reached $80.3 million in net sales, a new quarterly record. Software solutions net sales growth accelerated in the first quarter to 16% on an organic basis versus the first quarter of 2023, an increase from the growth trends over the last few quarters.
The growth in software solutions net sales was led by the performance of Venue, our virtual data room product, which posted 43% sales growth. We are encouraged by Venue’s strong performance, which reflects strong sales execution across Venue’s broad application within the M&A ecosystem that serves both announced and unannounced deals, as well as across public and private companies alike. This results in more resilient, stable demand than our transactional offerings. As a further demonstration of the momentum in our software solutions net sales, the growth trends of our recurrent compliance software products ActiveDisclosure and ArcSuite both improved in the first quarter, with each product delivering stronger year-over-year growth on a sequential basis compared to the fourth quarter of 2023.
Software Solutions made up 39.5% of total first quarter net sales, up approximately 420 basis points from last year’s first quarter net sales mix. On a trailing four quarter basis, Software Solutions net sales are now in excess of $300 million and represent 37.8% of total net sales, an increase of approximately 370 basis points from the first quarter 2023 trailing four quarter period. Looking ahead, we expect the growth rates for ActiveDisclosure and ArcSuite each to improve further in the second half of this year. For ActiveDisclosure, this improvement is driven by recent wins combined with overlapping last year’s platform transition. In the case of ArcSuite, the improved growth rate is primarily driven by the tailwind from the tailored shareholder reports regulation.
As we continue to evolve toward a higher sales mix of software solutions during the first quarter, that mix shift was accelerated by a reduction in print and distribution revenue, which declined by approximately $10 million or 20% compared to the first quarter of 2023. This reduction was evident mostly in the printing and distribution of annual reports and proxy statements, aligned with our strategy to manage our sales mix toward a proportionally heavier mix of higher margin tech-enabled services and software solutions net sales, while benefiting from the financial profile associated with such a sales mix. Dave will cover our results in more detail, but first I’d like to provide an update on our readiness for the Tailored Shareholder Reports Regulation ahead of its July 2024 compliance date.
As I’ve shared previously, we are making great progress in our technology development and go-to-market plan aimed to help our mutual fund and exchange traded funds clients operationalize the reporting to comply with this regulation, including being the first to market with the release of our TSR SaaS solution during the fourth quarter of last year. As we continue to mature and scale our TSR offerings, I’m excited by the end-to-end compliance solutions we have created for the regulation, giving DFIN an unmatched ability to serve clients the way they wish to work, via either SaaS -based solutions or traditional services, all in a one-stop shop that eliminates handoffs in the compliance process. In a further demonstration of our software product readiness, last week we announced DFIN successfully test filed the full form NCSR, including an IXBRL tag TSR to the SEC on behalf of a large asset manager.
The test filing was completed via our ArcReporting SaaS product, the leading financial close software for investment companies, and a component of our ArcSuite offering. The ArcReporting solution offers clients the ability to execute financial calculations, report generation at the fund and share class level, IXBRL tagging, reviewing, and filing, all through a single solution. Further, integrated data flow within ArcReporting eliminates the need for post-production reconciliation and guarantees consistency with the fund’s financial results at the shared class level. This successful test filing demonstrates the dynamic end-to-end, straight-through processing that ARcSuite offers our clients, enabling them to create, file, web host, and distribute complex financial reports all from a single platform.
In addition to the functionality offered by ArcReporting, DFIN is also ready to serve clients via traditional services for those who prefer that approach. In early April, we successfully completed the test filing of a full NCSR compliance document based on the new regulatory requirements, including IXBRL tagging of a tailored shareholder report by leveraging our industry leading service capabilities. This test filing to the SEC was done on behalf of another large asset manager and highlights DFIN’s deep expertise in the areas of IXBRL tagging and compliance filing. Our recent successful test filings represent an important milestone in our readiness journey and demonstrate DFIN’s leadership in the industry and commitment to deliver a streamlined solution for a complex regulation.
With less than three months to go until the July 2024 compliance date, DFIN remains very well positioned to serve our clients while capturing the recurring revenue opportunities associated with the tailored shareholder reports regulation. Before I share a few closing remarks, I would like to turn the call over to Dave to provide more details on our first quarter results and our outlook for the second quarter. Dave?
Dave Gardella: Thank you, Dan, and good morning, everyone. Before I discuss our first quarter financial performance, I’d like to recap two housekeeping items. First, during the quarter, we completed the sale of land in Phoenix, Arizona, the site of an office which we shut down and demolished in 2021 and was previously reflected on our consolidated balance sheet as an asset held for sale. The sale resulted in net proceeds of $13.2 million, of which $12.4 million was received in the first quarter of 2024 and %0.8 million of non-refundable fees were received in 2023. We recognize a net pre-tax gain of $10.6 million related to the sale of which $9.8 million was recorded in the first quarter of 2024 and $0.8 million was recognized in 2023.
The net pretax gain was recorded within the capital markets compliance and communications management operating segment under other operating income net line item. This gain is excluded from our non-GAAP results. Second, as discussed on last quarter’s earnings call, we completed the sale of our eBrevia business in the fourth quarter of 2023. For full year 2024, the disposition negatively impacts the year-over-year total net sales comparison by approximately $4 million with approximately $1 million net sales impact for each quarter. The impact on our gross profit and adjusted EBITDA comparisons is the minimus. For purposes of year-over-year net sales change discussions, organic net sales change adjusts for the impacts of the eBravia disposition, as well as changes in foreign currency exchange rates.
A reconciliation of reported to organic net sales change is included in our earnings release. Now, turning to our first quarter results, as Dan noted, we continue to demonstrate positive momentum in our performance during the first quarter by delivering consolidated net sales growth, a strong year-over-year increase in adjusted EBITDA, and improvements in both operating cash flow and free cash flow compared to the first quarter of 2023. By continuing our shift toward a more profitable sales mix, while also driving operating efficiencies, we expanded our first quarter adjusted EBITDA margin by 580 basis points to 27.1%. On a consolidated basis, total net sales for the first quarter of 2024 were $203.4 million, an increase of $4.8 million or 2.4% on a reported basis and 2.8% on an organic basis from the first quarter of 2023.
The growth in software solutions net sales, which increased $10.2 million or 16% on an organic basis, combined with higher capital markets transactional sales, more than offset a year-over-year decline in capital markets and investment companies’ compliance revenue with the vast majority of that decline related to print and distribution revenue that Dan highlighted earlier. Excluding print and distribution, net sales grew approximately 10%. First quarter adjusted non-GAAP gross margin was 60.6%, approximately 590 basis points higher than the first quarter of 2023, primarily driven by a favorable sales mix, including lower overall print volume and the impact of ongoing cost control initiatives, partially offset by incremental investments to accelerate our transformation.
Adjusted non-GAAP SG&A expense in the quarter was $68.1 million, a $1.8 million increase from the first quarter of 2023. As a percentage of net sales, adjusted non-GAAP SG&A was 33.5%, an increase of approximately 10 basis points from the first quarter of 2023. The increase in adjusted non-GAAP SG&A was primarily driven by an increase in selling expenses as a result of higher sales, higher bad debt expense, and higher incentive compensation expense, partially offset by lower third-party expenses and the impact of cost control initiatives. Our first quarter adjusted EBITDA was $55.2 million, an increase of $12.8 million or 30.2% from the first quarter of 2023. First quarter adjusted EBITDA margin was 27.1%, an increase of approximately 580 basis points from the first quarter of 2023, primarily driven by a favorable sales mix, higher overall sales, and cost control initiatives, partially offset by higher incentive compensation expense.
Turning now to our first quarter segment results, net sales in our capital market software solution segment were $53 million, an increase of 23.8% on an organic basis from the first quarter of last year, driven by the strong growth in Venue, our virtual data room product, which was up $10.2 million or 43.4% year-over-year and achieved record quarterly sales. Consistent with the recent trend during the first quarter, Venue continued to benefit from an increase in page volume on the platform and higher pricing. In addition, our strong sales execution resulted in several large client wins in the quarter with those projects combined to account for approximately half of Venue’s first quarter net sales growth. As Dan noted earlier, Venue’s consistent level of performance is a testament to the strong recurring demand for our virtual data room platform, as well as to our sales execution.
Going forward, we expect Venue to continue to deliver solid year-over-year growth, albeit at a more moderate pace compared to the robust growth rate we achieved in the first quarter of this year given the outsized impact of the large projects, in addition to overlapping Venue’s accelerated growth which started during the second quarter of 2023. Net sales of our recurring compliance product, ActiveDisclosure, including File 16, increased approximately 2% in the first quarter, driven primarily by growth in ActiveDisclosure service revenue, partially offset by lower Section 16 filing activity. The demand for beneficial ownership filings continues to be impacted by a weak IPO market as well as elevated client churn as we transition to a subscription-based model, a trend which we expect to continue in the near term.
Following a modest year-over-year decline in ActiveDisclosure subscription revenue in the fourth quarter, first quarter subscription revenue increased 4% sequentially and was flat versus the first quarter of last year. During the first quarter, we made continued progress to expand the adoption of ActiveDisclosure, resulting in the third consecutive quarter of net client count growth. The improvement in client count, combined with higher average price per client, is generating a solid foundation for future ActiveDisclosure revenue. To illustrate this in greater detail, ActiveDisclosure ACV from new logos during the first quarter is approximately double the level we achieved in the first quarter of 2023. The momentum in client count growth, coupled with product enhancements, create a strong foundation for future sales growth.
As we have stated previously, we expect active disclosures growth rate in the second half of 2024 to be stronger than in the first half, as some of the headwinds we experienced in 2023 continue to play out in the first half of 2024. Adjusted EBITDA margin for the segment was 29.8%, an increase of approximately 1,290 basis points in the first quarter of 2023, primarily due to higher sales and a favorable sales mix from the growth in our high margin Venue data room offering and cost control initiatives, partially offset by incremental investments in sales and marketing. Net sales in our capital markets compliance and communications management segment were $91.1 million, a decrease of $3 million or 3.2% from the first quarter of 2023, driven by lower capital markets compliance revenue predominantly lower margin print and distribution that Dan and I noted earlier, partially offset by higher transactional revenue.
In the first quarter, we recorded $48 million of capital market transactional revenue, an increase of approximately $7 million or 17% compared to last year’s first quarter and represents the first quarter of year-over-year revenue growth in this offering following two years of decline. We are encouraged by the year-over-year improvement in market activity during the first quarter, which resulted in increased deal volume across both IPOs and debt offerings compared to the first quarter of 2023, though M&A activity was down on a year-over-year basis. In short, the deal environment remains soft compared to historical averages. While the outlook for capital markets’ transactional environment is uncertain, DFIN remains very well-positioned to capture a significant share of future demand for transactional-related products and services when market activity picks up.
Adjusted EBITDA margin for the second was 34.5%, an increase of approximately 590 basis points from the first quarter of 2023. The increase in adjusted EBITDA margin was primarily due to a favorable sales mix featuring growth in high-margin capital markets transactional sales, and lower print and distribution revenue, as well as the impact of cost control initiatives, partially offset by higher incentive compensation expense and higher bad debt expense. Net sales in our investment company software solution segment were $27.3 million, an increase of 3.4% versus the first quarter of 2023, driven by growth in ArcSuite subscription revenue, which increased by approximately 9%, partially offset by lower services revenue compared to the first quarter of 2023, which benefited from higher one-time implementation revenue.
As we have stated previously, based on the incremental revenue from Tailored Shareholder Reports, we expect stronger ArcSuite revenue growth starting in the second half of 2024. We remain well-positioned to capture opportunities from regulatory changes to drive future recurring revenue growth. Adjusted EBITDA margin for the segment was 29.3%, a decrease of approximately 108 basis points from the first quarter of 2023. The decrease in adjusted EBITDA margin was primarily due to higher product development and technology investments in support of growth opportunities such as Tailored Shareholder Reports, offset by cost control initiatives and higher sales. Net sales in our investment companies compliance and communications management segment were $32 million, a decrease of $2.4 million or 7% from first quarter of 2023, driven primarily by a reduction in print and distribution revenue related to the long-term secular decline in the demand for printed materials.
Adjusted EBITDA margin for the segment was 25.6%, approximately 170 basis points lower than the first quarter of 2023. The decrease in adjusted EBITDA margin was primarily due to lower sales, partially offset by the impact of cost control initiatives. Non-GAAP unallocated corporate expenses were $8.2 million in the quarter, a decrease of $1.3 million from the first quarter of 2023. Primarily driven by lower third-party expenses and the impact of cost control initiatives, partly offset by an increase in expenses aimed at accelerating our transformation and higher healthcare costs. Free cash flow in the quarter was negative $40.2 million, an improvement of $21.9 million compared to the first quarter of 2023. The year-over-year improvement in free cash flow is primarily driven by an increase in adjusted EBITDA and favorable working capital, partially offset by higher capital expenditures related to investments in our software products and the underlying technology to support them.
We ended the quarter with $204.5 million of total debt and $160.8 million of non-GAAP net debt, including $80 million drawn on our revolver. From a liquidity perspective, we had access to the remaining $219 million of our revolver, as well as $43.7 million of cash on hand. As of March 31, 2024, our non-GAAP net leverage ratio was 0.7x. As a reminder, our cash flow is historically seasonal. We are a user of cash in the first quarter, closer to breakeven in the second quarter, and generate more than 100% of our free cash flow in the second half of the year. Regarding capital deployment, we repurchased approximately 140,000 shares of our common stock during the first quarter for $8.8 million at an average price of $62.61 per share. As of March 31, 2024, we had $141.2 million remaining on our $150 million stock repurchase authorization.
Going forward, we will continue to take a balanced approach toward capital deployment. We continue to view organic investments to drive our transformation, share repurchases, and net debt reduction, each as key components of our capital deployment strategy and will remain disciplined in this area. As it relates to our outlook for the second quarter of 2024, we expect the reduction in print and distribution revenue we highlighted earlier to continue in the second quarter, which historically is comprised of a heavy mix of print and distribution sales. This component of our sales profile becoming less significant over time continues to improve our overall sales mix and facilitates our long-term margin expansion. We said it’s the backdrop. We expect consolidated second quarter net sales in the range of $235 million to $250 million and adjusted EBITDA margin in the low 30% range.
Compared to the second quarter of last year, the midpoint of our consolidated revenue guidance, $242 million, implies consolidated net sales approximately flat to last year’s second quarter as the reduction in print and distribution sales is expected to offset growth in software solution sales. Further, this guidance assumes capital markets transactional sales of approximately $50 million, up approximately $5 million from last year’s second quarter and up $2 million from the $48 million we recorded in this year’s first quarter. With that, I’ll now pass it back to Dan.
Dan Leib: Thanks, Dave. Our performance in the first quarter offers a further proof point that our strategy and execution continue to make DFIN more durable and structurally resilient than in the past. As we progress on our transformation journey, we will continue to invest in opportunities to drive profitable recurring revenue growth, while also continuing to aggressively manage our cost structure and being disciplined stewards of capital. We are excited by the opportunities created by regulatory changes on the horizon. In the meantime, we are focused on creating best-in-class regulatory and compliance solutions to help our clients comply with those recurring regulations. 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 ensure our clients continue to receive the highest quality solutions. Now with that, we’re ready for questions.
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Q&A Session
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Operator: [Operator Instructions] And your first question comes from the line of Charles Strauzer with CJS Securities.
Charles Strauzer: Hi, good morning. How are you guys? I just want to touch base on one thing this morning on margin side, EBITDA margin, nice improvement year-over-year, also versus our model, just the factors that help kind of drive that along here, and are they expected to kind of continue in Q2 basic, when you look at guidance as well.
Dave Gardella: Yes, Charlie, this is Dave, I’ll take it. Thanks for the question. So a few things driving margin in Q1 most notably the favorable mix that we highlighted in the prepared remarks. And I would point to two things there. One is the tremendous growth that we saw in the Venue data room offering. And obviously the incremental margin on that is very high. And when you look at the 20% decline or so in the lower margin print revenue, right, you put those two things together and that really drives a lot of the margin improvement. The third thing I would point to or second thing I would point to, sorry, would be the work we continue to do on the cost structure, really being disciplined from a cost perspective. As we look at Q2 and beyond from a cost perspective, I think you can assume we’ll be — we’ll continue to be disciplined there, obviously overlapping some tougher comps as we go forward from overall cost structure perspective.
And then as we noted in the prepared remarks from a mixed perspective, a few things there. One, the software growth in particular for ActiveDisclosure and ArcSuite, expect — don’t expect much different from a growth perspective in Q2, but really ramping up in the back half of the year. Probably the one thing I would point to in Q2 and we noted some of the large Venue data rooms that we had in Q1 which drove about half the growth, it is tough to overcome and then we start to overlap tougher comps in Venue, but certainly from a print perspective which we also noted would expect that to come down. Overall, we would say margins roughly, in Q2 roughly flat to what we delivered last year and then like I said as you look into the back half of the year with the incremental software growth starting to improve there.
Charles Strauzer: Yes, and just if you look at kind of the improving IPO market, obviously, there’s a handful of good deals, good aftermarket performance and that could lead to obviously more transactions coming out of the pipeline. When you talk to your clients out there in the legal and banking side, what’s the tone there about an IPO’s?
Craig Clay: Hi, it’s Craig Clay. I’ll take that. I think first I’ll start with the leading indicator on the transactional market. After many quarters of decline, investment banks, finally this quarter, had fees for new issuance, debt, and M&A. They were up. So 27%, it’s the highest increase since the first quarter of ‘22 when the Fed started raising rates. So if you look at what happened in the quarter, certainly improved IPOs. It feels good to have a little bit of improvement. There were 16 companies that raised more than $50 million, $8 billion in the quarter. We had a 57% of that came from the healthcare sector, which is nice to see. DFIN is pleased to have supported 75% of the Q1 IPO filings. A lot of great names in there, BB Foods, BrightSpring, et cetera.
Nine of those 16 are trading well above their IPO price. So this is positive for the IPO market. Our clients are telling us that it’s an exciting thing as they look to the future. And I think if you look at April, we had 18 IPOs raised a combined $5.3 billion. This is just barely above the 10-year historical average by deal count and by proceeds, but I think the market will take it. It was the busiest month for overall new issuance, greater than $100 million since November of ‘21. Nine deals in the month, over $100 million. Our share was 67% of that. The largest deal in April, we were very happy to support was the billion-dollar offering of Viking. So Viking starts price last night, begins trading during this call. They price during or at the top of their range, and they increase the number of shares in the offering several times.
Another positive for the market, large VC Tech continued a comeback so we had Rubric which was nice to see so in April we also had new filings over $100 million there were eight which was a small increase from the prior month of six. So the previously commented, we remain encouraged, our clients remain encouraged by the process deals that are in process by the pent-up demand. We’re working with several highly marquee deals that are publicly filed. We also have some that are still confidential and given the steps our clients are taking to remain public or to go public. We think they’ll respond when the market opens. The Wall Street Journal mentioned last week that the recent success bodes well and companies potentially would move their IPO up.
We haven’t seen that publicly but we’re encouraged by the receptivity of the IPOs that have gone out and that the IPO market will continue to normalize into the summer.
Operator: Your next question comes from the line of Pete Heckmann with D.A. Davidson.
Pete Heckmann: Good morning. We had noticed that ourselves. I think we had counted 73% of the top maybe 15, I think you said 75% of the top 16. But what do you attribute that to? Just better competitive solutions from DFIN or are there some competitors that have fallen off or just kind of fortunate mix of a high retention rate amongst the IPOs that were going out?
Dave Gardella: Yes, thanks for the question. I think it’s a number of factors. I think our industry leading portfolio of solutions, we’re dedicated to our clients private to public journey. So we have a rich history in this space. I think when the market gets busy, we play an important part serving on their deal team, helping them project manage and providing most importantly the software to make that happen. So I think it’s about our clients and their moment of need turning to somebody who can provide the best solution for them. I think the exciting thing is that these are event driven transactions, but it’s providing this pipeline for recurring software, subscriptions that support our clients ongoing compliance. So the DFIN compliance platform, but also as you heard in the Venue results, that’s a leading indicator.
And it also supports the IPO market. Almost every one of these deals has a VDR associated with it as their dual track. I think what they’re getting, what our clients are getting when they come here is the trust, the clients having DFIN, they get their deal done, and then the support, the services, and the software, whether it’s ActiveDisclosure or Venue, that helps them do the work that they do.
Pete Heckmann: Okay, that’s helpful. And then how about on Tailored Shareholder Reports as we get one quarter closer to the goal line, any change in the thought process around the potential incremental benefit to DFIN or any higher confidence in that number?
