DONNELLEY FINANCIAL SOLUTIONS, INC. As used in this management's discussion and analysis, unless otherwise specified or the context otherwise requires, the "Company," "DFIN," "we," "our," and "us" refer toDonnelley Financial Solutions, Inc. and its consolidated subsidiaries. This discussion and analysis should be read in conjunction with the Company's unaudited condensed consolidated financial statements and accompanying notes as well as the Company's audited consolidated financial statements for the year endedDecember 31, 2019 . Company Overview DFIN is a leading global risk and compliance solutions company. The Company provides regulatory filing and deal solutions via its software technology-enabled services and print and distribution solutions to public and private companies, mutual funds and other regulated investment firms, to serve its clients' regulatory and compliance needs. DFIN helps its clients comply with applicable regulations where and how they want to work in a digital world, providing numerous solutions tailored to each client's precise needs. The prevailing trend is toward clients choosing to utilize the Company's software solutions, in conjunction with its tech-enabled services, to meet their document and filing needs, while at the same time shifting away from physical print and distribution of documents, except for cases where it is still regulatorily required or requested by shareholders. For corporate clients within its capital markets offerings, the Company offers solutions that allowU.S. public companies to comply with applicableU.S. Securities and Exchange Commission ("SEC") regulations including filing agent services, digital document creation and online content management tools that support their corporate financial transactions and regulatory reporting; solutions to facilitate clients' communications with their shareholders; and virtual data rooms and other deal management solutions. For the investment companies, including mutual fund and alternative investment companies, the Company provides solutions for creating and filing high-quality regulatory documents as well as solutions for investors designed to improve the speed and accuracy of their access to investment information. The Company serves its clients' regulatory and compliance needs throughout their respective life cycles. Technological advancements, regulatory changes, and evolving workflow preferences, have led to the Company's clients managing more of the financial disclosure process themselves, changing the marketplace for the Company's services and products. DFIN's strategy in its Software Solutions segments (CM-SS and IC-SS, as defined below) aligns with the changing marketplace by focusing the Company's investments and resources in its advanced software solutions, primarily ActiveDisclosure, FundSuiteArc and Venue®Virtual Data Room ("Venue"), while making targeted investments, such as the Company's acquisition of eBrevia to further broaden its solution set. In itsCompliance & Communications Management segments (CM-CCM and IC-CCM, as defined below), the Company's strategy focuses on maintaining its market-leading position by offering a high-touch, service-oriented experience, using its unique combination of tech-enabled services and print and distribution capabilities.
Market Volatility/Cyclicality
The Company'sCapital Markets segments (CM-SS and CM-CCM), in particular, are subject to market volatility inthe United States and world economy, as the success of the transactional and Venue offerings is highly dependent on the global market for initial public offerings ("IPOs"), secondary offerings, mergers and acquisitions ("M&A"), public and private debt offerings, leveraged buyouts, spinouts and other transactions. A variety of factors impact the global markets for transactions, including economic activity levels, market volatility, the regulatory and political environment, civil unrest and global pandemics, amongst others. The global transactional markets have been and continue to be disrupted due to the COVID-19 pandemic and its impacts to the overall economy and market volatility. Due to the significant net sales and profitability derived from transactional and Venue offerings, market volatility can lead to uneven financial performance when comparing to previous periods. The Company mitigates a portion of this volatility through its compliance offerings, supporting the quarterly and annual public company reporting processes through its filing services and ActiveDisclosure, as well as its investment companies regulatory and shareholder communications offerings, including FundSuiteArc. 24 --------------------------------------------------------------------------------
Services and Products
The Company separately reports its net sales and related cost of sales for its software solutions, tech-enabled services and print and distribution offerings. The Company's software solutions consist of Venue, ActiveDisclosure, eBrevia, FundSuiteArc, and others. The Company's tech-enabled services offerings consist of document composition, compliance-relatedSEC's Electronic Data Gathering, Analysis, and Retrieval ("EDGAR") filing services and transaction solutions. The Company's print and distribution offerings primarily consist of conventional and digital printed products and the related shipping.
Regulatory Developments
TheSEC is adopting new as well as amending existing rules and forms to modernize the reporting and disclosure of information by registered investment companies. These changes are driving significant regulatory changes which impact the Company's customers within its Investment Companies business. As further disclosed in the Company's Annual Report, onOctober 13, 2016 , theSEC adopted a new N-PORT filing requirement, which requires certain registered investment companies to report information about their portfolio in XML, a structured data format, on a monthly basis, replacing what was previously a quarterly filing requirement. This rule also includes an annual N-CEN filing in XML, replacing a semi-annual filing requirement. The first N-PORT filing deadlines began inApril 2019 for larger funds with over$1 billion in assets and, beginning inApril 2020 , smaller funds began filing N-PORT on a quarterly basis. The Company's ArcFiling software solution supports both filings. OnJune 5, 2018 , theSEC adopted Rule 30e-3 which provides certain registered investment companies with an option to electronically deliver shareholder reports and other materials rather than providing such reports in paper. Investors who prefer to receive reports in paper will continue to receive them in that format. While Rule 30e-3 was effectiveJanuary 1, 2019 , default electronic distribution pursuant to the rule will begin onJanuary 1, 2021 due to a 24-month transition period, during which registered investment companies must notify investors of the upcoming change in transmission format of shareholder reports. The Company expects a decline in the volume of printed annual and semi-annual shareholder reports in 2021 and beyond as a result of Rule 30e-3. OnMarch 11, 2020 , theSEC announced that it has adopted a new rule 498A under the Securities Act of 1933, as amended (the "Securities Act") and related regulatory amendments permitting variable annuity and variable life insurance contracts to use a more concise summary prospectus to provide disclosures to investors. More detailed information about the variable annuity or variable life insurance contract will be available online, and an investor can now choose to have that information delivered on paper. The new rule and related form amendments will become effective onJuly 1, 2020 with compliance required byJanuary 1, 2022 . The Company expects the majority of its insurance customers will adopt the rule by early 2021. As a result, the Company expects a decline in printed prospectus volume in 2021 and beyond. Based on the requirements of the rule, the Company is also expecting an increase in revenue from the ArcPro software solution and related regulatory filings.
Segments
In the first quarter of 2020, management realigned the Company's operating
segments to reflect changes in the manner in which the chief operating decision
maker assesses information for decision-making purposes. The Company's four
operating and reportable segments are: Capital Markets - Software Solutions
("CM-SS"), Capital Markets - Compliance and Communications Management
("CM-CCM"), Investment Companies - Software Solutions ("IC-SS"), and Investment
Companies - Compliance and Communications Management ("IC-CCM"). Corporate is
not an operating segment and consists primarily of unallocated selling, general
and administrative ("SG&A") activities and associated expenses, as further
described below.
All prior year amounts related to segments have been reclassified to conform to
the Company's current reporting structure. There is no impact on the Company's
previously reported consolidated statements of operations, statements of
comprehensive income, balance sheets, statements of cash flows or statements of
changes in stockholders' equity as a result of the new segmentation. For the
Company's financial results and the presentation of certain other financial
information by segment, see Note 13, Segment Information, to the Unaudited
Condensed Consolidated Financial Statements.
25
--------------------------------------------------------------------------------Capital Markets
The Company provides software solutions, technology-enabled services and print and distribution solutions to public and private companies for deal solutions and compliance to companies that are or preparing to become subject to the filing and reporting requirements of the Securities Act and the Securities Act of 1934, as amended (the "Exchange Act"). Capital markets' clients leverage the Company's software offerings, proprietary technology, deep industry expertise and experience to successfully navigate theSEC's specified file formats when submitting compliance documents through the EDGAR system for their transactional and ongoing compliance needs. The Company assists its capital markets clients throughout the course of public and private business transactions; M&A, IPOs, debt offerings and other similar transactions. In addition, the Company provides clients with compliance solutions to prepare their ongoing required Exchange Act filings that are compatible with theSEC's EDGAR system, most notably Form 10-K, Form 10-Q, Form 8-K and Proxy Form DEF 14A. The Company's operating segments associated with its capital markets services and products offerings are as follows: Capital Markets -Software Solutions-The Company provides software solutions to its capital markets clients through its CM-SS segment. The Company's Venue solution is a highly secure data room platform that allows clients to share confidential information in real-time throughout the transaction lifecycle. Clients can maintain control over sensitive data when conducting due diligence for M&A, raising capital for an IPO or developing a document repository. Specifically, companies have used Venue to securely organize, manage, distribute and track corporate governance, financing, legal and other documents in an online workspace accessible to internal and outside advisors. Via integration with the Company's eBrevia solution, Venue can use artificial intelligence to analyze documents to help clients better understand their content and make informed decisions. The Company's cloud-based ActiveDisclosure platform provides clients with end-to-end solutions to collaborate, tag, validate and file with theSEC efficiently. By leveraging its browser-enabled platform, ActiveDisclosure brings teams together across departments, functions and geographies in real time to create and edit Word, Excel or PowerPoint documents across devices, simultaneously. When combined with ActiveLink, a synchronous updating tool, ActiveDisclosure seamlessly flows changes throughout an entire document automatically, reducing risk and providing additional assurance to clients.
The Company's EDGAR® Online solution delivers intelligent solutions in financial disclosures, creating and distributing company data and public filings for equities, mutual funds and other publicly traded assets.
Capital Markets - Compliance & Communications Management-The CM-CCM segment provides technology-enabled services and print and distribution solutions for its capital markets clients. In addition, the Company offers clients the use of private conferencing facilities in most major cities in theU.S. and international jurisdictions to maintain confidentiality in deal negotiations and provide clients a place to host in-person working groups to meet, strategize and prepare documents for the transactional deal stream.
Investment Companies
The Company provides software solutions, technology-enabled services and print, distribution and fulfillment solutions to its investment companies clients that are subject to the filing and reporting requirements of the Securities Act of 1940, as amended (the "Investment Act"), primarily mutual fund companies, alternative investment companies, insurance companies and third-party fund administrators. The Company's suite of solutions enables its investment company clients to comply with applicable ongoingSEC regulations, as well as to create, manage, and deliver accurate and timely financial communications to investors and regulators. The Company also provides pre- and post-enrollment information to healthcare providers. Investment company clients leverage the Company's proprietary technology, deep industry expertise and experience to successfully navigate theSEC's specified file formats when submitting compliance documents through the EDGAR system. The Company's operating segments associated with its investment companies services and products offerings are as follows: Investment Companies -Software Solutions-The Company provides software products to its investment companies clients through its IC-SS segment. The Company's proprietary FundSuiteArc software platform provides clients with a comprehensive suite of cloud-based solutions and services that store and manage information in a self-service, central repository for compliance and regulatory documents to be easily accessed, assembled, edited, translated, rendered and submitted to regulators. FundSuiteArc offers cloud-based solutions featuring automation and single-source data validation that streamlines processes and drives efficiency for clients. FundSuiteArc includes ArcFiling, ArcReporting, ArcPro, and ArcRegulatory. 26 -------------------------------------------------------------------------------- Investment Companies - Compliance & Communications Management-Through its IC-CCM segment, the Company provides its investment companies clients with technology-enabled solutions for creating and filing high-quality regulatory documents and solutions for investor communications, as well as the eXtensible Business Reporting Language ("XBRL")-formatted filings pursuant to the Investment Act, through theSEC's EDGAR system. The IC-CCM segment also provides turnkey proxy services, including discovery, planning and implementation, print and mail management, solicitation, tabulation services, shareholder meeting review and expert support.
Corporate
The Company reports certain unallocated SG&A activities and associated expenses within Corporate, including, in part, executive, legal, finance, marketing, communications and certain facility costs. In addition, certain costs and earnings of employee benefit plans, such as pension and other postretirement benefit plan expense (income) and share-based compensation, are included in Corporate and are not allocated to the operating segments.
Executive Overview
First Quarter Overview
Net sales decreased by
Income from operations for the first quarter of 2020 increased by$5.3 million , or 80.3%, to$11.9 million from$6.6 million for the three months endedMarch 31, 2019 , primarily due to the favorable sales mix and the impact from cost control initiatives. COVID-19 InDecember 2019 , a novel strain of coronavirus, currently known as COVID-19 ("COVID-19"), was identified inChina and has since extensively impacted the global health and economic environment. OnMarch 11, 2020 , theWorld Health Organization ("WHO") characterized COVID-19 as a pandemic. Although COVID-19 has adversely impacted the Company's financial condition, results of operations and overall financial performance, the extent of that impact is currently uncertain and depends on factors including the impact on the Company's customers, employees and vendors. The COVID-19 pandemic may have a material adverse impact on the Company's customers' financial results, which may force the Company's clients to alter their plans for purchasing the Company's services and products. In addition, the global markets have been and continue to be disrupted due to the COVID-19 pandemic, which has negatively impacted the Company's transactional offerings and that negative impact is expected to continue. Some of this volatility is mitigated through the Company's compliance offerings, supporting the quarterly and annual public company reporting processes, as well as its investment companies regulatory and shareholder communications offerings. If the Company's customers reduce, defer or cancel their spending with DFIN, it would materially adversely impact the Company's business, results of operations and overall financial performance. Some of the Company's operations also have been affected by a range of external factors related to the COVID-19 pandemic that are not within the Company's control. For example, many jurisdictions have imposed a wide range of restrictions on the physical movement of the Company's employees and vendors to limit the spread of COVID-19. If the COVID-19 pandemic has a substantial impact on the Company's or vendors' employee attendance or productivity, the Company's operations are expected to be adversely affected, and in turn the Company's results of operations and overall financial performance would be harmed. Furthermore, the Company's insurance costs may increase. 27 -------------------------------------------------------------------------------- The Company has taken numerous steps, and will continue to take further actions, in its response to the COVID-19 pandemic. The Company has implemented business continuity plans and has instructed all employees that can work from home to do so, has implemented travel restrictions and has conducted virtual customer and employee meetings. These decisions may delay or reduce sales and harm productivity and collaboration. The Company has also incurred$0.8 million of incremental expenses as a result of the COVID-19 pandemic during the three months endedMarch 31, 2020 , including incremental vendor costs, premium wages paid to certain employees as well as costs to clean and disinfect the Company's facilities more frequently. The Company expects to continue to incur such costs in future periods, however, the impact of such costs on the Company's financial condition, results of operations and overall financial performance cannot be predicted at this time. The Company is also working closely with its clients to support them as they implement their own contingency plans, helping them access the Company's services and products and continue to meet their regulatory requirements. The Company believes that implementing cost reduction efforts will help mitigate the impact that reduced revenues will have on 2020 income from operations. The Company has reduced expenses and may take further actions that alter its business operations as the situation evolves. The ultimate impact of the COVID-19 pandemic and the effects on the Company's business, financial condition, liquidity, and financial results cannot be predicted at this time. Refer to "Risk Factors" for further discussion of the impact of the COVID-19 pandemic on the Company's business.
Financial Review
The preparation of financial statements in conformity with accounting principles generally accepted inthe United States ("GAAP") requires the extensive use of management's estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates. The Company's significant accounting policies and critical estimates are disclosed in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , as filed with theSEC onFebruary 26, 2020 (the "Annual Report").
In the financial review that follows, the Company discusses its unaudited condensed consolidated results of operations, cash flows and certain other information. This discussion should be read in conjunction with the Company's Unaudited Condensed Consolidated Financial Statements and the related notes.
Results of Operations for the Three months ended
The following table shows the results of operations for the three months ended
Three Months Ended March 31,
2020 2019 $ Change % Change
(in millions, except percentages)
Net sales
Tech-enabled services $ 81.9 $ 83.2 $ (1.3 ) (1.6 %)
Software solutions 47.3 44.7 2.6 5.8 %
Print and distribution 91.5 101.7 (10.2 ) (10.0 %)
Total net sales 220.7 229.6 (8.9 ) (3.9 %)
Cost of sales (1)
Tech-enabled services 42.8 48.8 (6.0 ) (12.3 %)
Software solutions 24.8 26.6 (1.8 ) (6.8 %)
Print and distribution 68.7 78.5 (9.8 ) (12.5 %)
Total cost of sales 136.3 153.9 (17.6 ) (11.4 %)
Selling, general and administrative
expenses (1) 57.0 54.9 2.1 3.8 %
Depreciation and amortization 12.4 12.1 0.3 2.5 %
Restructuring, impairment and other
charges, net 3.1 2.1 1.0 47.6 %
Income from operations 11.9 6.6 5.3 80.3 %
Interest expense, net 4.6 8.9 (4.3 ) (48.3 %)
Investment and other income, net (0.4 ) (0.6 ) 0.2 (33.3 %)
Earnings (loss) before income taxes 7.7 (1.7 ) 9.4 nm
Income tax expense (benefit) 3.6 (0.3 ) 3.9 nm
Net earnings (loss) $ 4.1 $ (1.4 ) $ 5.5 nm
________________
(1) Exclusive of depreciation and amortization.
nm - Not meaningful
28
--------------------------------------------------------------------------------
Consolidated
Net sales of tech-enabled services for the three months endedMarch 31, 2020 decreased$1.3 million , or 1.6%, to$81.9 million , versus the three months endedMarch 31, 2019 . Net sales of tech-enabled services decreased due to lower capital markets transactional and compliance volumes.
Net sales of software solutions for the three months ended
Net sales of print and distribution for the three months endedMarch 31, 2020 decreased$10.2 million , or 10.0%, to$91.5 million versus the three months endedMarch 31, 2019 . Net sales of print and distribution decreased due to lower mutual funds compliance and transactional print, lower commercial print and lower capital markets transactional print. Tech-enabled services cost of sales for the three months endedMarch 31, 2020 decreased$6.0 million , or 12.3%, to$42.8 million , compared to the three months endedMarch 31, 2019 , primarily due to the impact of the lower volumes and cost control initiatives. As a percentage of tech-enabled services net sales, tech-enabled services cost of sales decreased 6.4% as a result of cost control initiatives. Software solutions cost of sales decreased$1.8 million , or 6.8%, to$24.8 million , for the three months endedMarch 31, 2020 versus the three months endedMarch 31, 2019 , primarily due to the impact of cost control initiatives. As a percentage of software solutions net sales, software solutions cost of sales decreased 7.1% as a result of cost control initiatives. Print and distribution cost of sales decreased$9.8 million , or 12.5%, to$68.7 million , for the three months endedMarch 31, 2020 versus the three months endedMarch 31, 2019 . Print and distribution cost of sales decreased due to the lower volumes and cost control initiatives. As a percentage of print and distribution net sales, print and distribution cost of sales decreased 2.1% as a result of cost control initiatives. SG&A expenses increased$2.1 million , or 3.8%, to$57.0 million , for the three months endedMarch 31, 2020 , as compared to the three months endedMarch 31, 2019 , primarily due to higher healthcare benefit claims. As a percentage of net sales, SG&A expenses increased from 23.9% for the three months endedMarch 31, 2019 to 25.8% for the three months endedMarch 31, 2020 due to higher healthcare benefit claims and higher commission expenses due to sales mix. Depreciation and amortization increased$0.3 million , or 2.5%, to$12.4 million for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 2019 . Depreciation and amortization included$3.4 million and$3.7 million of amortization of other intangible assets related to customer relationships and a tradename for the three months endedMarch 31, 2020 and 2019, respectively. Restructuring, impairment and other charges, net for the three months endedMarch 31, 2020 , were$3.1 million , as compared to$2.1 million for the three months endedMarch 31, 2019 . In 2020, these charges included$1.6 million for employee termination costs of 51 employees, substantially all of whom were terminated as ofMarch 31, 2020 , and$1.5 million for other charges primarily related to the realignment of the Company's operating segments. In 2019, these charges included$2.0 million of employee termination costs for 72 employees, substantially all of whom were terminated as ofMarch 31, 2019 .
Income from operations for the three months ended
Interest expense, net decreased$4.3 million to$4.6 million for the three months endedMarch 31, 2020 versus the same period in 2019, due to the payoff of the Company's term loan credit facility in 2019 and the$2.3 million gain on debt extinguishment during three months endedMarch 31, 2020 , as further described in Note 8, Debt, partially replaced by the Revolving Facility (as defined below) that carries a lower interest rate. Investment and other income, net for both the three months endedMarch 31, 2020 and the three months endedMarch 31, 2019 primarily consisted of net pension plan income. 29
-------------------------------------------------------------------------------- The effective income tax rate was 46.8% for the three months endedMarch 31, 2020 compared to 17.6% for the three months endedMarch 31, 2019 . The effective income tax rate for the three months endedMarch 31, 2020 was primarily driven by the Company's inability to recognize a tax benefit on certain losses. The effective income tax rate for the three months endedMarch 31, 2019 reflects lower earnings as well as a decrease in the taxation of certain foreign earnings.
Information by Segment
The following tables summarize net sales, income from operations and certain items impacting comparability within each of the operating segments and Corporate.
Capital Markets - Software Solutions
Three Months Ended March 31,
2020 2019 $ Change % Change
(in millions, except percentages)
Net sales $ 31.2 $ 30.5 $ 0.7 2.3 %
Income from operations 1.8 0.1 1.7 nm
Operating margin 5.8 % 0.3 %
Items impacting comparability
Restructuring, impairment and
other charges, net 0.3 0.3 - -
________________
nm - Not meaningful
Net sales for the three months ended
Income from operations increased
Operating margins increased from 0.3% for the three months endedMarch 31, 2019 to 5.8% for the three months endedMarch 31, 2020 primarily due to cost control initiatives.
Capital Markets - Compliance and Communication Management
Three Months Ended March 31,
2020 2019 $ Change % Change
(in millions, except percentages)
Net sales $ 99.1 $ 102.0 $ (2.9 ) (2.8 %)
Income from operations 21.4 14.7 6.7 45.6 %
Operating margin 21.6 % 14.4 %
Items impacting comparability
Restructuring, impairment and
other charges, net 0.5 0.9 (0.4 ) (44.4 %)
COVID-19 related expenses 0.3 - 0.3 nm
_____________
nm - Not meaningful
Net sales for the three months ended
Income from operations increased
Operating margins increased from 14.4% for the three months endedMarch 31, 2019 to 21.6% for the three months endedMarch 31, 2020 primarily due to cost control initiatives and a favorable sales mix. 30 --------------------------------------------------------------------------------
Investment Companies - Software Solutions
Three Months Ended March 31,
2020 2019 $ Change % Change
(in millions, except percentages)
Net sales $ 16.1 $ 14.2 $ 1.9 13.4 %
Income (loss) from operations 0.1 (3.7 ) 3.8 nm
Operating margin 0.6 % (26.1 %)
Items impacting comparability
Restructuring, impairment and
other charges, net 0.3 0.1 0.2 nm
________________
nm - Not meaningful
Net sales for the three months ended
Income from operations increased
Operating margins increased from a negative margin of 26.1% for the three months endedMarch 31, 2019 to 0.6% for the three months endedMarch 31, 2020 primarily due to cost control initiatives.
Investment Companies - Compliance and Communication Management
Three Months Ended March 31,
2020 2019 $ Change % Change
(in millions, except percentages)
Net sales $ 74.3 $ 82.9 $ (8.6 ) (10.4 %)
Income from operations 2.1 6.7 (4.6 ) (68.7 %)
Operating margin 2.8 % 8.1 %
Items impacting comparability
Restructuring, impairment and
other charges, net 0.4 0.4 - -
COVID-19 related expenses 0.5 - 0.5 nm
________________
nm - Not meaningful
Net sales for the three months ended March 31, 2020 were $74.3 million , a
decrease of $8.6 million , or 10.4%, compared to the three months ended March 31,
2019 primarily due to lower mutual funds compliance and transactional volumes
and lower commercial print volumes.
Income from operations decreased $4.6 million , or 68.7%, to $2.1 million
compared to the three months ended March 31, 2019 , primarily due to the lower
sales volumes and COVID-19 related expenses, partially offset by cost control
initiatives.
Operating margins decreased from 8.1% for the three months ended March 31, 2019
to 2.8% for the three months ended March 31, 2020 primarily due to the lower
sales volume, partially offset by cost control initiatives.
31
--------------------------------------------------------------------------------Corporate
The following table summarizes unallocated operating expenses and certain items impacting comparability within the activities presented as Corporate:
Three Months Ended March 31,
2020 2019
(in millions)
Operating expenses $ 13.5 $ 11.2
Items impacting comparability
Share-based compensation expense 2.3 1.5
Restructuring, impairment and other charges, net 1.6 0.4
eBrevia contingent consideration (0.4 ) -
Investor-related expenses - 1.0
Spin-off related transaction expenses - 0.4
Corporate operating expenses for the three months ended March 31, 2020 increased
$2.3 million , or 20.5%, versus the same period in 2019 primarily due to higher
restructuring, impairment and other charges, net as a result of the realignment
of the Company's operating segments as well as higher healthcare benefit claims
and higher share-based compensation expense, partially offset by lower
investor-related expenses.
Non-GAAP Measures
The Company believes that certain Non-GAAP measures, such as Non-GAAP adjusted
EBITDA ("Adjusted EBITDA"), provide useful information about the Company's
operating results and enhance the overall ability to assess the Company's
financial performance. The Company uses these measures, together with other
measures of performance under GAAP, to compare the relative performance of
operations in planning, budgeting and reviewing the performance of its
business. Adjusted EBITDA allows investors to make a more meaningful comparison
between the Company's core business operating results over different periods of
time. The Company believes that Adjusted EBITDA, when viewed with the Company's
results under GAAP and the accompanying reconciliations, provides useful
information about the Company's business without regard to potential
distortions. By eliminating potential differences in results of operations
between periods caused by factors such as depreciation and amortization methods,
historic cost and age of assets, restructuring, impairment and other charges,
acquisition-related expenses and gain or loss on certain equity investments and
asset sales, the Company believes that Adjusted EBITDA can provide a useful
additional basis for comparing the current performance of the underlying
operations being evaluated.
Adjusted EBITDA is not presented in accordance with GAAP and has important
limitations as an analytical tool. These measures should not be considered as a
substitute for analysis of the Company's results as reported under GAAP. In
addition, these measures are defined differently by different companies and,
accordingly, such measures may not be comparable to similarly-titled measures of
other companies.
In addition to the factors listed above, the following items are excluded from Adjusted EBITDA:
• Share-based compensation expense. Although share-based compensation is a key
incentive offered to certain of the Company's employees, business
performance is evaluated excluding share-based compensation expenses.
Depending upon the size, timing and the terms of grants, non-cash
compensation expense may vary but will recur in future periods.
• COVID-19 related expenses. Incremental expenses incurred as a result of the
COVID-19 pandemic, including incremental vendor costs, premium wages paid to
certain employees and additional costs to clean and disinfect the Company's
facilities more frequently.
• Investor-related expenses. Expenses incurred related to non-routine investor
matters, which include third-party advisory and consulting fees and legal
fees.
32
--------------------------------------------------------------------------------
• Spin-off related transaction expenses. The Company has incurred expenses
related to the 2016 separation from R.R. Donnelley & Sons Company ("RRD")
(the "Separation") to operate as a standalone publicly traded company. These
expenses included third-party consulting fees, information technology
expenses, employee retention payments, legal fees and other costs related to
the Separation, including system implementation expenses related to
transitioning from transition service agreements with RRD and LSC
Communications, Inc. Management does not believe that these expenses are
reflective of ongoing operating results.
A reconciliation of GAAP net earnings (loss) to Adjusted EBITDA for the three
months ended March 31, 2020 and 2019 for these adjustments is presented in the
following table:
Three Months Ended March 31,
2020 2019
(in millions)
Net earnings (loss) $ 4.1 $ (1.4 )
Restructuring, impairment and other charges, net 3.1 2.1
Share-based compensation expense 2.3 1.5
COVID-19 related expenses 0.8 -
eBrevia contingent consideration (0.4 ) -
Investor-related expenses - 1.0
Spin-off related transaction expenses - 0.4
Depreciation and amortization 12.4 12.1
Interest expense, net 4.6 8.9
Investment and other income, net (0.4 ) (0.6 )
Income tax expense (benefit) 3.6 (0.3 )
Adjusted EBITDA $ 30.1 $ 23.7
Restructuring, impairment and other charges, net-The three months ended
March 31, 2020 included $1.6 million for employee termination costs and $1.5
million for other charges, primarily related to the realignment of the Company's
operating segments. The three months ended March 31, 2019 included $2.0 million
for employee termination costs and $0.1 million for other charges.
Share-based compensation expense-Included charges of
COVID-19 related expenses-Included charges of$0.8 million for the three months endedMarch 31, 2020 , primarily related to incremental vendor costs and premium wages paid to certain employees.
eBrevia contingent consideration-Included a gain of
Investor-related expenses-Included charges of
Spin-off related transaction expenses-Included charges of$0.4 million for the three months endedMarch 31, 2019 primarily related to third-party consulting fees.
Liquidity and Capital Resources
The Company believes it has sufficient liquidity to support its ongoing operations and to invest in future growth to create value for its shareholders. Cash on hand, operating cash flows and the Company's$300.0 million senior secured revolving credit facility (the "Revolving Facility") are the primary sources of liquidity and are expected to be used for, among other things, payment of interest and principal on the Company's debt obligations, capital expenditures necessary to support productivity improvement and growth, acquisitions and completion of restructuring programs. 33 -------------------------------------------------------------------------------- The Company maintains cash pooling structures that enable participating international locations to draw on the pools' cash resources to meet local liquidity needs. Foreign cash balances may be loaned from certain cash pools toU.S. operating entities on a temporary basis in order to reduce the Company's short-term borrowing costs or for other purposes. The Company has the ability to repatriate any previously taxed foreign cash associated with the foreign earnings subject to theU.S. parent with minimal tax consequences. The Company maintains its assertion of indefinite reinvestment on all foreign earnings and other outside basis differences to indicate that the Company remains indefinitely reinvested in operations outside of theU.S. with the exception of the previously taxed foreign cash already subject toU.S. tax. The Company repatriated excess cash at its foreign subsidiaries to theU.S. during the year endedDecember 31, 2019 and does not plan to make cash repatriations during 2020.
Cash and cash equivalents of
The following describes the Company's cash flows for the three months endedMarch 31, 2020 and 2019. Three Months Ended March 31, 2020 2019 (in millions) Net cash used in operating activities$ (37.1 ) $ (68.3 ) Net cash used in investing activities (8.2 ) (17.1 ) Net cash provided by financing activities 37.5 47.1 Effect of exchange rate on cash and cash equivalents (1.7 ) 1.5 Net decrease in cash and cash equivalents$ (9.5 )
Cash Flows Used in Operating Activities
Operating cash inflows are largely attributable to sales of the Company's services and products as well as recurring expenditures for labor, rent, raw materials and other operating activities.
Net cash used in operating activities was$37.1 million for the three months endedMarch 31, 2020 compared to$68.3 million for the three months endedMarch 31, 2019 . The decrease in cash used in operating activities of$31.2 million was primarily due to favorable operating results and a decrease in income taxes paid. Cash paid for income taxes, net of refunds, decreased by$11.8 million to$2.0 million for the three months endedMarch 31, 2020 , from$13.8 million for the three months endedMarch 31, 2019 , due primarily to the payment of taxes in 2019 on the gain from the 2018 sale of the Language Solutions business. Accounts receivable decreased operating cash flows by$55.7 million for the three months endedMarch 31, 2020 , as compared to$63.6 million for the three months endedMarch 31, 2019 due to increased collection efforts and the timing of customer payments in the three months endedMarch 31, 2020 . Accounts payable and accrued liabilities and other increased operating cash flows by$8.5 million for the three months endedMarch 31, 2020 , as compared to a$0.6 million increase in operating cash flows for the three months endedMarch 31, 2019 , primarily due to the timing of supplier payments.
Cash Flows Used in Investing Activities
Net cash used in investing activities was
Net cash used in investing activities was$17.1 million for the three months endedMarch 31, 2019 , and primarily consisted of capital expenditures of$15.1 million , mostly driven by an investment in digital printers and investments in software development. 34
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Cash Flows Provided by Financing Activities
Net cash provided by financing activities for the three months ended
Net cash provided by financing activities was$47.1 million for the three months endedMarch 31, 2019 . During the three months endedMarch 31, 2019 , the Company received$178.5 million of proceeds from the Revolving Facility borrowings, partially offset by$130.0 million of payments on the Revolving Facility borrowings. The Company's common stock repurchases for the three months endedMarch 31, 2019 totaled$1.2 million .
Debt
The Company's debt as ofMarch 31, 2020 andDecember 31, 2019 consisted of the following (in millions): March 31, 2020 December 31, 2019 8.25% senior notes due October 15, 2024 $ 233.5 $
300.0
Borrowings under the Revolving Facility 106.0
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Unamortized debt issuance costs (2.9 ) (4.0 ) Total long-term debt $ 336.6 $ 296.0 8.25% Senior Notes Due 2024- OnSeptember 30, 2016 , DFIN (the "Parent") issued$300.0 million of 8.25% senior unsecured notes dueOctober 15, 2024 (the "Notes"). The Company's Notes, with interest payable semi-annually onApril 15 andOctober 15 , were issued pursuant to an indenture (the "Indenture") where certain wholly-owned domestic subsidiaries of the Company guarantee the Notes (the "Guarantors"). In the first quarter of 2020, the Company purchased and retired$66.5 million (notional amount) of the Notes at an average price of 95.25 and recognized a pre-tax gain on the extinguishment of debt of$2.3 million , which was net of unamortized debt issuance costs, and is recorded within interest expense, net in the Unaudited Condensed Consolidated Statements of Operations. The Notes are fully and unconditionally as well as jointly and severally guaranteed, on an unsecured basis, by the Guarantors, which are comprised of each of the Company's existing and future direct and indirect wholly-ownedU.S. subsidiaries that guarantee the Company's obligations under the Credit Facilities, includingDonnelley Financial, LLC andDFS International Holding, Inc. The Notes are not guaranteed by the Company's foreign subsidiaries or unrestricted subsidiaries ("Nonguarantors"). The Indenture governing the Notes contains certain covenants applicable to the Company and its restricted subsidiaries, including limitations on: (1) liens; (2) indebtedness; (3) mergers, consolidations and acquisitions; (4) sales, transfers and other dispositions of assets; (5) loans and other investments; (6) dividends and other distributions, stock repurchases and redemptions and other restricted payments; (7) restrictions affecting subsidiaries; (8) transactions with affiliates; and (9) designations of unrestricted subsidiaries. Each of these covenants is subject to important exceptions and qualifications. The Notes and the related guarantees are the Company and the Guarantors', respective, senior unsecured obligations and rank equally in right of payment to all present and future senior debt, including the obligations under the Company's Credit Facilities, senior in right of payment to all present and future subordinated debt, and effectively subordinated in right of payment to any of the Company and the Guarantors' secured debt, to the extent of the value of the assets securing such debt. The guarantee of the Notes by a subsidiary guarantor will be automatically released under certain situations, including upon the sale or disposition of such subsidiary guarantor to a person that is not DFIN or a subsidiary guarantor of the notes, the liquidation or dissolution of such subsidiary guarantor, and if such subsidiary guarantor is released from its guarantee obligations under the Company's Credit Facilities. 35 -------------------------------------------------------------------------------- The following summarized financial information of both the Parent and the Guarantors is presented on a combined basis; intercompany balances and transactions between the Parent and the Guarantors have been eliminated and the summarized financial information does not reflect investments of the Parent or the Guarantors in Nonguarantors. The Parent's or Guarantor's amounts due from, amounts due to, and transactions with Nonguarantor are disclosed below: March 31, 2020 December 31, 2019 (in millions) Current assets $ 222.6 $ 169.5 Noncurrent assets 1,028.3 1,034.8 Current liabilities 172.7 165.2 Noncurrent liabilities 464.2 431.1 Three Months Ended March 31, 2020 (in millions) Total net sales $ 198.7 Total cost of sales 122.3 Income from operations 14.2 Net earnings 5.3 During the three months endedMarch 31, 2020 , Nonguarantors intercompany revenue and cost of sales totaled$2.6 million each. As ofMarch 31, 2020 , andDecember 31, 2019 , an intercompany short-term note receivable due to Nonguarantors from the Parent totaled$4.0 million and$12.0 million , respectively. Credit Agreement-The Credit Agreement contains a number of covenants, including, but not limited to, a minimum Interest Coverage Ratio and the Consolidated Net Leverage Ratio, as defined in and calculated pursuant to the Credit Agreement, that, in part, restrict the Company's ability to incur additional indebtedness, create liens, engage in mergers and consolidations, make restricted payments and dispose of certain assets. The Credit Agreement generally allows annual dividend payments of up to$20.0 million in aggregate, though additional dividends may be allowed subject to certain conditions. Each of these covenants is subject to important exceptions and qualifications. As ofMarch 31, 2020 , outstanding borrowings under the Revolving Facility totaled$106.0 million . The maturity date of the Revolving Facility isDecember 18, 2023 . Based on the Company's results of operations for the twelve months endedMarch 31, 2020 and existing debt, the Company would have had the ability to utilize an incremental$194.0 million of the$300.0 million Revolving Facility and not have been in violation of the terms of the agreement. The current availability under the Revolving Facility and net available liquidity as ofMarch 31, 2020 is shown in the table below: March 31, 2020 Availability (in millions) Revolving Facility $ 300.0 Availability reduction from covenants
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$ 300.0
Usage
Borrowings under the Revolving Facility
106.0
Impact on availability related to outstanding letters of credit
-
$ 106.0
Current availability at March 31, 2020 $ 194.0
Cash 7.7
Net Available Liquidity $ 201.7
36
-------------------------------------------------------------------------------- The Company was in compliance with its debt covenants as ofMarch 31, 2020 , and expects to remain in compliance based on management's estimates of operating and financial results for 2020 and the foreseeable future. However, declines in market and economic conditions or demand for certain of the Company's services and products could impact the Company's ability to remain in compliance with its debt covenants in future periods. The failure of a financial institution supporting the Revolving Facility would reduce the size of the Company's committed facility unless a replacement institution was added. As ofMarch 31, 2020 , the Revolving Facility is supported by sixteenU.S. and international financial institutions. As ofMarch 31, 2020 , the Company had$3.8 million in outstanding letters of credit and bank guarantees, of which none reduced the availability under the Revolving Facility. As ofMarch 31, 2020 , the Company met all the conditions required to borrow under the Revolving Facility, and management expects the Company to continue to meet the applicable borrowing conditions.
Acquisitions
The Company's acquisition of eBrevia closed onDecember 18, 2018 . During the year endedDecember 31, 2019 , the Company paid an additional$4.5 million related to the acquisition of eBrevia;$1.9 million of the purchase price related to the amounts held in escrow was payable as ofMarch 31, 2020 and is expected to be paid during 2020.
OTHER INFORMATION
Litigation and Contingent Liabilities
For a discussion of certain litigation involving the Company, see Note 7, Commitments and Contingencies, to the Unaudited Condensed Consolidated Financial Statements.
Critical Accounting Policies and Estimates
The Company has updated its accounting policies related to valuation reserves associated with accounts receivable in conjunction with the adoption of ASU 2016-13, as further described in Note 1, Overview, Basis of Presentation and Significant Accounting Policies, to the Unaudited Condensed Consolidated Financial Statements. Except for the adoption of ASU 2016-13, there were no other changes to critical accounting policies and estimates from those disclosed in "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" of the Annual Report.Goodwill As discussed in Note 1, Overview, Basis of Presentation and Significant Accounting Policies, to the Unaudited Condensed Consolidated Financial Statements, during the first quarter of 2020, management realigned the Company's operating segments. DFIN's four operating and reportable segments are the same as its reporting units: CM-SS; CM-CCM; IC-SS; and IC-CCM ("Current Structure"). The Company previously had three reporting units: Capital Markets, Investment Markets and International ("Previous Structure"), that each had goodwill. As a result of the new segmentation, a goodwill impairment analysis was completed for the Previous Structure, before the reallocation of goodwill to the Current Structure. Each of the reporting units under the Previous Structure were reviewed for impairment as ofMarch 31, 2020 using a quantitative assessment, where the estimated fair value of each reporting unit was compared to its carrying amount, including goodwill. If the carrying amount ("book value") of a reporting unit exceeds its estimated fair value, an impairment loss is generally recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. As a result of theMarch 31, 2020 goodwill impairment analysis under the Previous Structure, the Company did not recognize any goodwill impairment as the estimated fair values of all reporting units exceeded their respective carrying amounts. In addition to the impairment analysis under the Previous Structure, a goodwill impairment analysis was completed under the Current Structure.Goodwill was also reassigned within the Current Structure using a relative fair value approach. 37 -------------------------------------------------------------------------------- Quantitative Assessment-The analysis performed included estimating the fair value of each reporting unit using both the income and market approaches. The income approach requires management to estimate a number of factors for each reporting unit, including projected future operating results, economic projections, anticipating future cash flows, discount rates and the allocation of shared or corporate items. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping. The Company weighted both the income and market approach equally to estimate the concluded fair value of each reporting unit.
The determination of fair value in the quantitative assessment requires the Company to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; the discount rate; terminal growth rates; and forecasts of revenue; operating income; depreciation and amortization; restructuring charges and capital expenditures.
Goodwill Impairment Assumptions- Although the Company believes its estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting units, the amount of goodwill impairment charge, or both. One measure of the sensitivity of the amount of goodwill impairment charges to key assumptions is the amount by which each reporting unit "passed" (fair value exceeds carrying amount, a "cushion") or "failed" (the carrying amount exceeds fair value) the quantitative assessment. As a result of theMarch 31, 2020 goodwill impairment analysis under the Current Structure, the Company did not recognize any goodwill impairment as the estimated fair values of all reporting units exceeded their respective carrying amounts. CM-SS, CM-CCM and IC-SS all had fair values far in excess of book values; however, the IC-CCM reporting unit's fair value exceeded its book value by approximately 3%. The small amount of cushion between book value and fair value of the IC-CCM reporting unit is primarily driven by the projected negative impact of regulatory developments for certain services and products. As ofMarch 31, 2020 , goodwill allocated to the IC-CCM reporting unit was$40.6 million . Generally, changes in estimates of expected future cash flows would have a similar effect on the estimated fair value of the reporting unit. That is, a 1.0% decrease in estimated annual future cash flows would decrease the estimated fair value of the reporting unit by approximately 1.0%. The estimated long-term net sales growth rate can have a significant impact on the estimated future cash flows, and therefore, the fair value of each reporting unit. Holding all other assumptions constant, a 1.0% decrease in the long-term net sales growth rate would not have resulted in an impairment loss for any of the Company's reporting units. Of the other key assumptions that impact the estimated fair values, most reporting units have the greatest sensitivity to changes in the estimated discount rate. The discount rate for the IC-CCM reporting unit was 12.0%. Holding all other assumptions constant, a 1.0% increase in the estimated discount rate would have resulted in the fair value of the IC-CCM reporting unit approximating its book value. A 1.0% increase in the discount rate would not have resulted in an impairment for any of the other reporting units under the Current Structure. The Company believes its estimates of future cash flows and discount rates are reasonable, but future changes in the underlying assumptions could occur due to the inherent uncertainty in making such estimates. Additionally, the COVID-19 pandemic has created significant uncertainty in the macroeconomic and business outlook. Further price deterioration, lower volumes, additional unfavorable regulatory developments or lower than expected profitability of software products still in development could have a significant impact on the fair values of the reporting units. Further declines in the Company's operating results due to challenging economic conditions, an unfavorable industry or macroeconomic development or other adverse changes in market conditions could change one of the critical assumptions or estimates the Company uses to calculate the fair value of its reporting units which could result in a decrease in fair value and require the Company to record a goodwill impairment charge in future periods. The Company performs its goodwill impairment tests annually as ofOctober 31 or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company also performs an interim review for indicators of impairment each quarter to assess whether an interim impairment review is required for any reporting unit. 38
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New Accounting Pronouncements and Pending Accounting Standards
Recently issued accounting standards and their estimated effect on the Company's condensed consolidated financial statements are described in Note 1, Overview, Basis of Presentation and Significant Accounting Policies, to the Unaudited Condensed Consolidated Financial Statements.
CAUTIONARY STATEMENT
The Company has made forward-looking statements in this Quarterly Report on Form 10-Q within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of the Company. Generally, forward-looking statements include information concerning possible or assumed future actions, events, or results of operations of the Company. These statements may include words such as "anticipates," "estimates," "expects," "projects," "forecasts," "intends," "plans," "continues," "believes," "may," "will," "goals" and variations of such words and similar expressions are intended to identify the Company's forward-looking statements. Forward-looking statements are not guarantees of performance. The following important factors, in addition to those discussed elsewhere in this Quarterly Report on Form 10-Q, could cause the Company's actual results to differ materially from those indicated in any such forward-looking statements. These factors include, but are not limited to:
• the adverse impacts of the COVID-19 pandemic and other global public health
epidemics on the Company's business and operations, including demand for
DFIN services and products, and the Company's ability to effectively manage
the impacts of the coronavirus on its business operations;
• the volatility of the global economy and financial markets, and its impact
on transactional volume;
• failure to offer high quality customer support and services;
• the retention of existing, and continued attraction of additional clients;
• the growth of new technologies with which the Company may be able to
adequately compete;
• the Company's inability to maintain client referrals;
• the competitive market for the Company's products and industry fragmentation
affecting prices;
• the ability to gain client acceptance of the Company's new products and
technologies;
• delay in market acceptance of the Company's services and products due to
undetected errors or failures found in the Company's services and products;
• failure to maintain the confidentiality, integrity and availability of the
Company's systems, software and solutions;
• failure to properly use and protect client and employee information and data;
• the effect of a material breach of security or other performance issues of
any of Company's or its vendors' systems;
• factors that affect client demand, including changes in economic conditions,
national or international regulations and clients' budgetary constraints;
• the Company's ability to access debt and the capital markets due to adverse
credit market conditions;
• the effect of increasing costs of providing healthcare and other benefits to
employees;
• changes in the availability or costs of key materials (such as ink and
paper) or in prices received for the sale of by-products;
• failure to protect the Company's proprietary technology;
• failure to successfully integrate acquired businesses;
• availability to maintain the Company's brands and reputation;
• the retention of existing, and continued attraction of, key employees,
including management;
• the effects of operating in international markets, including fluctuations in
currency exchange rates; and
• the effect of economic and political conditions on a regional, national or
international basis.
39
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Because forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Undue reliance should not be placed on such statements, which speak only as of the date of this document or the date of any document that may be incorporated by reference into this document. Consequently, readers of the Quarterly Report on Form 10-Q should consider these forward-looking statements only as the Company's current plans, estimates and beliefs. The Company does not undertake and specifically declines any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. The Company undertakes no obligation to update or revise any forward-looking statements in this Quarterly Report on Form 10-Q to reflect any new events or any change in conditions or circumstances.
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