Donnelley Financial Solutions, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. The filing covers the unaudited quarter and nine months ended September 30, 2016. Donnelley Financial provides financial communications, compliance, transaction, data and analytics, and language services, alongside printed products. These are carve-out combined financial statements derived from R.R. Donnelley & Sons Company (RRD), not results of a company operating independently throughout the periods. Donnelley Financial became independent on October 1, 2016; its shares began regular-way NYSE trading on October 3 under DFIN.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $224.4 million | $231.6 million | $762.5 million | $810.9 million |
| Income from operations | $18.0 million | $28.2 million | $99.5 million | $134.6 million |
| Net earnings | $10.2 million | $16.8 million | $59.9 million | $81.1 million |
| Diluted earnings per share | $0.31 | $0.52 | $1.85 | $2.50 |
| Non-GAAP adjusted EBITDA | $29.5 million | $39.9 million | $133.2 million | $169.9 million |
- Q3 services sales were $139.4 million, down 1.9%; products sales were $85.0 million, down 5.0%. For the nine months, services sales fell 5.4% to $454.1 million and products sales fell 6.8% to $308.4 million.
- Operating margin was approximately 8.0% in Q3 versus 12.2% a year earlier, and 13.0% for the nine months versus 16.6%. Net margin was approximately 4.5% and 7.3% in Q3, and 7.9% and 10.0% for the nine-month periods, respectively.
- Q3 effective tax rate was 43.6% versus 39.8%, reflecting additional tax reserves and accrued interest. The nine-month rate was 39.6% versus 39.3%.
- Nine-month operating cash flow was $56.8 million versus $59.0 million. Investing used $17.0 million, including $14.0 million of capital expenditures and $3.5 million of investment purchases. Financing used $6.1 million; ending cash was $53.0 million, up from $15.1 million at year-end 2015.
- At September 30, cash was $53.0 million and current assets were $290.2 million against current liabilities of $162.1 million. The company had no borrowings on its $300 million revolving facility, leaving the full stated capacity available, subject to its terms.
- Debt at September 30 included a $348.2 million term loan and $300 million of 8.25% senior notes due October 2024, less $11.7 million of unamortized issuance costs, for $636.5 million reported debt. Contractual principal was $650 million. Total liabilities were $825.4 million.
Material changes and management commentary
- Q3 sales decreased 3.1%; management attributed the decline primarily to lower capital-markets transaction and compliance volumes, partly offset by growth in virtual data rooms and translation services. For the nine months, management also cited lower mutual-fund and commercial-print volumes and investment-market price pressures.
- Operating income fell 36.2% in Q3 and 26.1% for the nine months. Q3 products cost of sales rose 15.2%, with management citing unfavorable print mix, price pressures, and wage and other inflation. Selling, general and administrative expense increased, including costs related to becoming independent.
- The U.S. segment, the larger business, reported Q3 sales of $192.3 million, down 4.6%, and operating margin of 9.7% versus 14.0%. International Q3 sales increased 7.0% to $32.1 million and operating margin rose to 3.4% from 0.7%. For the nine months, both segments had lower sales and margins.
- The September 30 financing was arranged in connection with the spin-off. Term-loan proceeds included $340.2 million paid to RRD under the separation agreement; the $300 million notes were issued as part of an exchange settling certain RRD bonds. Credit agreements include leverage and interest-coverage covenants and restrict certain actions and payments.
- After quarter-end, on October 1, the company recorded $68.3 million of net pension liabilities transferred from RRD, comprising $317.0 million of benefit liabilities less $248.7 million of plan assets. RRD was also required to pay the company $68.0 million by April 1, 2017; that receivable was recorded as of October 1.
Outlook, risks and contingencies
- The filing provides no specific quantified earnings or revenue guidance. Management said it believes liquidity is sufficient for operations and investment, drawing on cash, operating cash flow, and the revolving facility.
- Management described the business as exposed to economic and financial-market volatility, especially transaction volumes, and to seasonal filing peaks. It cited technology shifts that enable clients to manage disclosure processes themselves, intense and fragmented competition, pricing pressure, and the need to invest in technology and recurring-revenue offerings.
- Other disclosed risks include separation-related costs and operating challenges, dependence on RRD and LSC transition and commercial agreements (generally up to 24 months), cybersecurity and client-data protection, customer retention, foreign exchange, access to capital, and availability or cost of paper and ink. The company said raw-material price changes are generally passed through, but resulting demand effects are uncertain.
- Transition services and commercial arrangements with RRD and LSC support the move to stand-alone operations. The company assumed a headquarters lease through 2024 with $14.1 million of commitments and a related $6.2 million sublease to RRD; it remains secondarily liable if RRD defaults on the sublease.
- Management said ordinary-course litigation and potential bankruptcy-related preference claims were not expected to materially affect results, financial position, or cash flows. The company reported no material changes to the risk factors in its Form 10 registration statement.
Important facts for investors to verify
- How stand-alone expenses and margins compare with the historical RRD allocations, which management cautioned may not represent future independent-company costs.
- Whether transaction volumes, print mix, pricing, and cost inflation continue to pressure revenue and operating margins, and whether growth in virtual data rooms, translation, and content management offsets those trends.
- Debt terms, covenant headroom, interest costs, and cash available after the separation-related payment to RRD; also track the expected $68 million RRD payment and its timing.
- Execution of the transition to independent systems and operations, reliance on RRD and LSC arrangements, and the transfer and funding of pension obligations.
- That the reported periods are pre-separation carve-out results, while the spin-off, financing, and pension transfer occurred at or after quarter-end.