Donnelley Financial Solutions, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; financial amounts are in millions except per-share data. The company provides financial communications, compliance, transaction, software, data and language services to capital and investment markets.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $290.6 | $290.2 | $545.8 | $557.5 |
| Operating income | $36.2 | $42.0 | $55.6 | $68.4 |
| Net earnings | $18.9 | $18.8 | $26.6 | $28.1 |
| Diluted EPS | $0.56 | $0.57 | $0.78 | $0.86 |
| Non-GAAP adjusted EBITDA | $63.4 | $63.0 | $104.2 | $107.2 |
- Q2 services sales rose 6.1% to $187.9; product sales fell 9.2% to $102.7. Higher capital-markets transactions, virtual data room and content-management activity partly offset weaker mutual-fund print and compliance volumes.
- For the first half, services sales increased 4.9% to $347.4, but products fell 12.4% to $198.4, leaving total sales down 2.1%. The company cited lower mutual-fund print and capital-markets compliance volumes.
- Operating income fell 13.8% in Q2 and 18.7% for the first half. SG&A increased 22.3% in Q2 and 18.8% year to date, primarily from spin-off-related and system-implementation expenses as the company transitioned from services agreements. Q2 spin-off costs were $8.4; first-half costs were $16.2.
- Consolidated operating margin was approximately 12.5% in Q2 versus 14.5% a year earlier, and 10.2% for the first half versus 12.3%. Q2 U.S. segment margin declined to 19.3% from 19.9%; International fell to 3.3% from 12.2%, reflecting weaker transaction activity, mix and restructuring costs.
- Effective tax rates declined to 30.5% for Q2 and 30.7% for the first half, from 41.1% and 41.5%, respectively, primarily due to the Tax Act. Net earnings were nearly flat in Q2 but lower for the first half.
Cash flow, debt and liquidity
- First-half operating cash flow was negative $50.2, compared with negative $39.4 a year earlier. Management attributed the deterioration mainly to timing of customer receipts and higher incentive-compensation payments, partly offset by lower tax and interest payments. Receivables used $102.1 of cash.
- Investing cash outflow was $15.6, including $15.6 of capital expenditures. Financing provided $27.4. Cash declined $40.2 from year-end to $11.8.
- At June 30, debt was $486.3 net of issuance costs: $300.0 of 8.25% senior notes due 2024, $168.7 term loans and $27.0 drawn on the revolving facility. Contractual debt principal was reported as $497.0. Debt increased from $458.3 at December 31, 2017.
- Reported net available liquidity was $154.4, comprising $142.6 of revolver availability after covenant-related limits and $11.8 cash. The company was in covenant compliance and expected to remain compliant, while warning that weaker demand or economic conditions could affect future compliance.
- Management expected 2018 capital expenditures of $40–$45, compared with $27.8 in 2017. No full-year revenue or earnings guidance was provided in the filing text.
Material developments, outlook and risks
- After quarter-end, the company sold its Language Solutions business for $77.5 cash; the sale closed July 22, 2018. It used approximately $60.0 of net proceeds to repay term-loan debt in July. At June 30, assets and liabilities associated with the business were classified as held for sale.
- The company adopted the new revenue-recognition standard on January 1, 2018. It accelerated recognition for certain arrangements and deferred some virtual-data-room revenue. The standard reduced Q2 net earnings by $1.6, or $0.05 per share, versus the previous standard; first-half net earnings were unchanged. Comparatives were not restated.
- Management highlighted market and transaction-volume volatility, technology-driven competition and customer self-service, pricing pressure, cybersecurity and data-protection risks, client and employee retention, and the costs and risks of operating independently after separation. It expects SEC Rule 30e-3 to reduce printed shareholder-report volumes beginning in 2021, while anticipating additional services demand from more frequent investment-company filings under N-PORT.
- The company expects the new lease standard, to be adopted in 2019, to add a lease liability and corresponding right-of-use asset for substantially all operating leases, materially affecting the balance sheet; it did not expect a significant income-statement effect for existing operating leases.
- Restructuring charges were $2.6 in Q2 and $3.3 for the first half. Management said ordinary-course litigation and potential bankruptcy preference claims were not expected to materially affect results, financial position or cash flows. The company reported effective disclosure controls and no material changes in internal control.
Important facts for investors to verify
- Whether service growth can offset continued declines in product, mutual-fund print and compliance volumes, and whether segment margins recover.
- How much of elevated SG&A and spin-off transition spending will continue, and whether adjusted EBITDA translates into sustainable operating cash flow.
- Post-sale debt balances and liquidity after the Language Solutions proceeds and term-loan repayment; also monitor covenant headroom and variable-rate exposure.
- The timing and effect of the Language Solutions divestiture on continuing revenue, earnings and segment comparisons.
- Whether the expected $40–$45 capital-expenditure program and the 2019 lease-accounting change affect cash needs or reported leverage more than anticipated.