Donnelley Financial Solutions, Inc. Q2 FY2025 earnings call

• Delivered solid second quarter results with record quarterly software solutions net sales, strong adjusted EBITDA margin, and increases in operating and free cash flow. - Software solutions net sales grew ~8% y-o-y, with recurring compliance software offerings up ~15% y-o-y. - Capital markets transactional offerings faced challenges in April but saw improving trends from May to June. - Second quarter adjusted EBITDA margin was 35%, the second highest quarterly EBITDA margin in history. - Software products continued to show momentum despite Venue facing tough comparisons. - Print and distribution net sales declined by ~$14 million or 26% compared to Q2 2024. - Continues to execute strategy to transform into leading provider of compliance and regulatory solutions via software and services, on track with 5-year plan.

1. Software Solutions: Posted approximately 8% sales growth, including ~15% growth in recurring compliance software offerings. Software solutions made up 42.3% of total second quarter net sales, up ~700 basis points from last year's second quarter. On a trailing 4-quarter basis, software solutions comprised 45.1% of total net sales, an increase of ~610 basis points from the second quarter 2024 trailing 4-quarter period. 2. Capital Markets Software Solutions: Net sales were $59.1 million, an increase of $1.8 million or 3.1% from the second quarter of last year, driven by ActiveDisclosure up $2.2 million year-over-year, partially offset by a slight decline in Venue. 3. Capital Markets Compliance and Communications Management: Net sales were $93.5 million, a decrease of $20.3 million or 17.8% from the second quarter of 2024, driven by lower transactional revenue and compliance volume. 4. Investment Company Software Solutions: Net sales were $33.1 million, an increase of $4.8 million or 17% versus the second quarter of 2024, primarily driven by incremental revenue from Tailored Shareholder Report solution. 5. Investment Companies Compliance and Communications Management: Net sales were $32.4 million, a decrease of $10.9 million or 25.2% from the second quarter of 2024, primarily driven by lower print and distribution volume.

• Expected consolidated third quarter net sales in the range of $165 million to $175 million and adjusted EBITDA margin in the range of 23% to 25%. - Capital markets transactional net sales expected in the range of $35 million to $40 million. - Venue expected to be approximately flat to last year's third quarter. - Tailored Shareholder Report solution's growth will overlap in the second half of 2024, expecting more normalized growth rate from the third quarter.

• Uncertainty in capital markets transactional activity due to market volatility and macroeconomic factors. - Continued secular decline in demand for printed products affecting print and distribution revenue. - Uncertainty regarding the timing and cash impact of pension annuitization process.

Q: So if we look at the Q3 guidance and the granularity of the transactional guidance within that, maybe you can shed a little bit more light on the assumptions behind that and kind of like what the deal environment is looking like currently for both IPOs and M&A, especially M&A given the change in administration?

A: Yes. Thanks, Charlie. It's Dave. I'll start and Craig may want to add a little bit of color here. I think when you look at our guidance for transactional sales for Q3, right, the range of $35 million to $40 million, that's sequential growth over Q2 and up to about 15% at the high end of that range. As you know, and we've talked about before, this is the area where we have the least visibility in terms of timing of getting the deals done. So while we feel good about the underlying trend in market activity, I'd say, as it relates to the guidance, trying not to get too far over our skis here. I think probably the most positive is regardless where transactional revenue comes in, we're very happy with the margins and cash flow that we're delivering. Obviously, you could see that in the Q2 results, the year-to-date results as well as our guidance for Q3. With respect to the market activity, M&A, IPO, Craig, I'll let you comment there.

Q: Just looking at the nontransactional segments, as we think about guidance in general, what assumptions should we be using when we model out the quarter?

A: Yes, Charlie, I think we didn't give too much detail here. But I think when you look at some of the software products, right, which is where we've seen the growth in the first 2 quarters, right? ActiveDisclosure has posted 11% year-to-date growth. And so that's been a really strong area for us, and we expect that to continue to grow going forward. As we mentioned in the prepared remarks, the growth in Arc Suite has been outsized in the first part of the year, in part because of the timing of the launch of the Tailored Shareholder Reports regulation, right? So that started in Q3 of last year. We'll be overlapping some of the growth we achieved last year in Arc Suite. So that will be tempered a bit. And then Venue has got pretty tough comps throughout the year, right? We saw some outsized growth. As we mentioned, even Q2 was down a bit, but that's coming off a quarter that grew at 38% last year. And so I think when you look at kind of the Venue being flattish in Q2 -- sorry, in Q3 relative to last year is probably a reasonable assumption there. And then on the traditional compliance, right, so the compliance and communications management nontransactional piece, that will continue to be challenged from a print count perspective. As you know, we've seen that trend for a while and would expect that trend to continue. But there, again, even as it relates to Tailored Shareholder Reports, where we saw a drop in overall print demand related to that regulation, that impact started in the back half of last year offsetting the growth on the software side.

Q: Can you just remind us some of the assumptions behind your long-term goals?

A: Yes. So it's really, I think, at the highest level, it's continuing to execute the change in mix, right, growing the recurring and reoccurring software offerings, continuing to expand margin in large part due to the operating leverage on that growth. And then from a capital markets transactional perspective, at the time, we made the assumption that there would be not much of a change in the overall level of capital markets transactional revenue. Obviously, that's come down quite a bit actually since last February. And so that's an area that it's cyclical. It's -- we do a good job in terms of maintaining or growing our market share, but can't really impact the overall demand there. And then I would say the last thing in terms of the revenue mix, we do assume and we talked a little bit about it today, some of the sales that are currently in the Compliance and Communications Management segments transitioning to software. And we've seen that happen over the last several quarters, whether it be some of the structured forms, proxy work, et cetera, continuing to migrate toward, we would say, in the near term, a hybrid model that would be leveraging the software and then also the tech-enabled services behind that. But eventually migrating to software, continuing to expand margins and then probably from a cash flow perspective, converting EBITDA to free cash flow at about 45% or greater.

Q: When you look at the strong performance of cash flow in the quarter, and then look at the full year, are you expecting full year free cash flow to be up year-over-year?

A: So we're obviously ahead of where we were on a year-to-date basis. I think when you look at -- we've talked about over the last several years really as the top line is proportionately more software solution sales, more long-term contracts, more pay in advance that our cash flow would become less seasonal than it has been historically. And so I think what we're starting to see is the cash flow being less seasonal, which is giving us a bit of a head start. At the highest level, if I had to say what would cash flow look like on a full year basis, I'd say pretty similar to last year.

Q: Just going back to the deal environment, are you maintaining a good share of the deals that are out there? And if you lose a deal to another competitor, what are the reasons behind that?

A: Yes, I'll start and then, Craig, if you want to jump in. I think I would describe it as we're happy with our overall share performance. I think -- and Craig can get into some of the nuances here, as Craig commented on even with the overall improving market backdrop in terms of the number of deals. I think when you start to look at some of the characteristics of the deals that have been in the market, smaller foreign deals or even smaller domestic deals, SPACs, et cetera, our market share in some of the lower-end deals isn't typically as high as it is for the larger high-profile deals. And so I think when you look at overall share, it's about what we would expect, but we're really happy with how we're performing in our sweet spot. Craig?

Q: I just wanted to, I guess, follow up a little bit on the outlook with the capital markets guide, I guess, it was a little softer than we were expecting given that there does seem to be an improving pipeline. I know you mentioned that the confidential filings seem like they're -- they do seem to be picking up. Is some of that activity converting and closing? Is some of that in the outlook for 3Q? Or are you guys taking a more conservative outlook in the guide for cap markets?

A: Yes, Kyle, as I said earlier, I think when you look at that $35 million to $40 million range, at $40 million, that's up roughly 15% relative to the Q2 number. I guess I would describe it this way without getting into the details of any particular deal would be to say that if the trend that we saw in Q2 in terms of the intra-quarter improvement from month-to-month, if that trend continues, I would say we would be at the high end of the guidance, potentially above if that trend continues. So we're just taking a look at the improvement, again, given the lack of visibility in terms of the exact timing, as I said to Charlie, just trying not to get too far over our skis there.

Q: As a follow-up on capital allocation it sounds like based on the authorization. It sounds like it's still full after it's authorized like halfway through the quarter. So it seems like you guys kind of front-loaded buybacks this quarter. Do you still think that, that will be an important part of the toolkit moving forward? Or are you guys being sensitive around valuation and where the stock is at?

A: Yes. So I think as we said in the prepared remarks that we view share repurchases as a key component of capital allocation. To your point, and also consistent with what we've done historically and said that our path would be forward, right, is that at the higher prices, we're less aggressive, at the lower prices, we're more aggressive, and that will continue to be the path forward.

Q: Do you have any update on the pension? I think you guys were planning on doing kind of an annuitization and kind of converting that over just to clean up the balance sheet a little bit. Any update on either the expected timing or cash impact or anything that we should be mindful of as that process continues?

A: Yes. So the update on timing, that process is underway. Things are coming out, I'd say, generally in line with kind of the assumptions we made going into it. We still haven't gone out to annuitize the plan and work with the insurers to take that over. That will happen during the third quarter. And so on the Q3 call, potentially before then, we'll have additional news to share in terms of the cash outlay and what that looks like.