Donnelley Financial Solutions, Inc. quarterly report, Q3 FY2017

Donnelley Financial Solutions, Inc. — Q3 2017 Form 10-Q

Business and period: The company provides financial communications, regulatory compliance, transaction, data and analytics, and language services, alongside printed products. This unaudited report covers the three and nine months ended September 30, 2017. The company became independent of R.R. Donnelley (RRD) on October 1, 2016; prior-period results include combined, pre-separation reporting and allocated parent-company costs, limiting comparability with the stand-alone business.

Financial results and liquidity

Metric	Q3 2017	Q3 2016	Nine months 2017	Nine months 2016
Net sales	$222.6m	$224.4m	$780.1m	$762.5m
Operating income	$18.0m	$18.0m	$88.1m	$99.5m
Net earnings	$5.3m	$10.2m	$33.4m	$59.9m
Diluted EPS	$0.16	$0.31	$1.01	$1.85
Operating cash flow	Not stated for quarter	Not stated for quarter	$33.7m	$56.8m

Q3 sales declined 0.8% year over year: services rose 0.6% to $140.3m, while products fell 3.2% to $82.3m. Nine-month sales increased 2.3%, led by 3.8% growth in services.
Q3 operating margin was approximately 8.1%, versus 8.0% a year earlier; nine-month operating margin was approximately 11.3%, down from 13.0%. The nine-month decline reflected lower transaction and healthcare-print volumes and higher stand-alone company costs.
Q3 net earnings fell despite flat operating income, chiefly reflecting $10.6m of net interest expense versus net interest income of $0.1m in Q3 2016. Nine-month net interest expense was $32.7m, versus $0.3m.
Non-GAAP adjusted EBITDA was $32.3m in Q3 versus $29.7m, and $141.2m for nine months versus $134.4m. The measure excludes, among other items, restructuring, share-based compensation, separation costs, depreciation and amortization, interest, and taxes; it is not a GAAP measure.
At September 30, cash was $32.2m, current assets $290.2m, and current liabilities $184.5m. Long-term debt carrying value was $488.4m, including $300m of 8.25% senior notes and a $198.5m term loan; the $300m revolving facility had no borrowings. Reported net available liquidity was $293.2m, including $261.0m of revolver availability.
Nine-month investing cash use was $23.1m, including $20.0m of capital expenditures; financing cash use was $15.2m. Cash declined $4.0m from year-end 2016 to $32.2m.

Material changes and management commentary

In Q3, U.S. sales declined 3.2% to $186.1m, while International sales rose 13.7% to $36.5m. U.S. operating income increased to $22.4m from $18.7m; International operating income increased to $1.5m from $1.1m.
For the first nine months, U.S. sales declined 0.6% to $658.2m, while International sales increased 21.8% to $121.9m. International operating margin fell to 6.2% from 7.2%, partly due to higher allocated expenses and restructuring costs.
Management attributed weaker transaction-related results to lower capital-markets activity; higher mutual-fund print-related services, compliance, virtual data room, and content-management work partly offset declines. Management cited cost controls but also higher costs of operating independently, including compensation, selling, technology, share-based compensation, and separation expenses.
During the nine months, the company recorded $6.4m of restructuring, impairment and other charges, including termination costs for 169 employees. Most affected employees had been terminated by September 30; employee termination payments were expected to be substantially complete by March 31, 2018. Some lease-related payments extend to 2026.
After quarter-end, on October 2, 2017, the term loan was repriced: its rate fell by 100 basis points to LIBOR plus 3.0%, with a 0.75% LIBOR floor. Quarterly principal payments were added. The stated maturity and covenants remained consistent with the prior agreement.

Outlook, risks and contingencies

No specific revenue or earnings guidance is provided. Management expected 2017 capital expenditures of approximately $30m–$35m, compared with $26.2m in 2016, and stated it believed liquidity was sufficient for operations and planned investment.
Management expects to remain in compliance with debt covenants but warned that weaker markets or lower demand could affect future compliance. As of September 30, the company was in compliance and had $261m of revolver availability after covenant-related restrictions.
Key risks include cyclical capital-markets transaction volumes, competition and technology-driven client self-service, client retention, cybersecurity and data protection, costs and execution of stand-alone operations, foreign exchange, access to credit, and obligations under transition and other separation agreements. Management said market and economic volatility can materially affect transaction-sensitive business.
Ordinary-course litigation and potential bankruptcy preference claims were disclosed; management did not expect their resolution to materially affect results, financial position, or cash flows. The company also remains secondarily liable on its headquarters lease if the subtenant defaults, but does not expect material payments from that provision.
Management reported effective disclosure controls as of September 30, 2017. It stated there were no material changes to the risk factors in its 2016 Form 10-K.

Key facts for investors to verify

Whether the apparent improvement in adjusted EBITDA translates into durable GAAP earnings and operating cash flow, given the substantial interest burden and excluded items.
Whether transaction-volume softness persists and whether recurring compliance, investment-market, data-room, and language-services growth can offset it.
The sustainability of cost reductions and the extent to which stand-alone, technology, compensation, and restructuring costs continue.
The term-loan repricing’s effect on interest expense and cash payments, together with covenant headroom and the availability of the revolving facility.
The cash-flow implications of receivables growth, planned capital expenditures, restructuring and lease obligations, and the transition away from RRD/LSC services.
The impact of adopting revenue-recognition and lease accounting standards; the filing says the company was evaluating the revenue standard’s effect and the lease standard’s impact.