Dye & Durham Limited (OTCPK:DYNDF) Q2 2024 Earnings Conference Call February 13, 2024 8:00 AM ET
Matt Proud – Chief Executive Officer
Frank Di Liso – Chief Financial Officer
Huss Hirji – Vice President, Investor Relations
Conference Call Participants
Robert Young – Canaccord Genuity
Thanos Moschopoulos – BMO Capital Markets
Kevin Krishnaratne – Scotiabank
Scott Fletcher – CIBC Capital Markets
Good morning. My name is Lara and I will be your conference Operator today.
At this time, I would like to welcome everyone to the Dye & Durham second quarter fiscal 2024 earnings call.
I would now like to turn the call over to Huss Hirji, VP, Investor Relations, Dye & Durham. Mr. Hirji, you may begin your conference.
Thank you Lara, and good morning. Welcome to the Dye & Durham conference call.
Before we start, we’d like to remind you that all amounts discussed on this call are denominated in Canadian dollars unless otherwise indicated. Please note that statements made during this call may include forward-looking statements and information and future oriented financial information regarding Dye & Durham and its business and disclosure regarding possible events, conditions, or results that are based on information currently available to management which indicate management’s expectation of future growth, results of operations, business performance and business prospects, as well as opportunities. Such statements are made as of the date hereof and Dye & Durham assumes no obligation to update or revise them to reflect events, disclosures or circumstances, except as required by applicable securities laws. Such statements involve significant risks and uncertainties and are not a guarantee of future performance or results.
A number of these risks or uncertainties could cause results to differ materially from the results discussed today. Given these risks and uncertainties, one should not place undue reliance on these statements and information. Please refer to the forward-looking statements and information on future oriented financial information section of our public filings without limitation, our MD&A, and our earnings press release issued today for additional information.
Joining us on the call today are Matt Proud, Dye & Durham’s Chief Executive Officer, and Frank Di Liso, Dye & Durham’s Chief Financial Officer. A question and answer session will follow the formal remarks for research analysts.
I will now turn the call over to Matt for opening remarks. Matt?
Thanks Huss, and good morning everybody.
The business performed really well in what is typically a seasonally low quarter. We’re up 17% in revenue, taking into account the impact from the TM divestiture. We continue to grow our contracted revenue. Annual contracted revenue was $203 million or 49% of total revenue as of December 31, 2023. Contracted revenue consists of ARR, which was $112 million as of December, again representing 27% of revenue, and other contracted revenue from contract overages or service agreements, which was $93 million.
We’re building a business of scale, delivering mission critical software to law firms and financial institutions. The legal technology vertical was a $25 billion market in 2023 and is estimated to grow to be $46 billion in 2030 – this is according to third party reports. Our practice management and daily insights and due diligence solutions address the market’s fastest growing needs; as such, we’re well positioned to win in this market. Our practice management solutions help small and medium-sized law firms manage and grow their practices with key applications like case and matter management, as well as core business functions like accounting, billing, client on-boarding, work flow management and document management. Earlier this month, we announced the launch of our Unity global platform. We initially launched this in the U.K. and expect to launch later in Australia and Canada – that’s later this year.
We’ve built a business through acquisition. We have a very large customer base with multiple core product offerings in each of our markets. These offerings solve law firms’ needs which are critical to their business and customers. Building through acquisition means you don’t necessarily have a uniform platform for clients to use across the functions. The U.S. is also different – the customer experience is different, it’s more difficult to leverage the brand across different applications as well. The Unity global platform solves this. It solves these challenges by bringing together all the acquisitions we have compiled in one seamless way for our customers.
It was a big project for us and the team delivered in a very big way. The Unity global platform makes it more streamlined for customers to access a range of products and services in one location. With one log-in, you get access to everything you need to manage your practice. Law firms can now reduce their administrative burden and reclaim time to earn fees dedicated to client services and in turn grow their business faster with less effort.
Our competitors don’t offer the same capabilities across comprehensive applications that we offer. For instance, the Unity global platform includes a fully integrated client on-boarding solution, allowing law firms to quickly get binding engagement letters signed by their customers and at the same time allows them to seamlessly take their customers through the digital ID verification, KYC and AML process. We believe the world-class capabilities of the Unity global platform position us effectively to compete and continue to win market share.
By offering a single global platform for essential industry-leading software solutions, we’re positioned more strongly than we ever have been to lead in the global technology industry. At the same time, we’re designing, building and launching new platforms. We’ve also taken a series of important steps as part of our larger plan to strengthen the business.
First, we’ve strengthened our balance sheet and restructured a large portion of our convertible debt which, taken together, have significantly improved our capital structure and provides us greater flexibility. Specifically, since our last call, we increased and completed the $160 million substantial issuer bid for the 2026 convertible debentures. There is now $185 million left in principal amount outstanding on the 2026s compared to $345 million at the time of our last call. We also issued $140 million in new debentures due November 1, 2028. These new debentures do not have the same accelerated maturity as the 2026 convertibles. In effect, we’ve termed out $160 million for an increased yield to maturity of 2.6%.
Additionally, earlier this month we raised $145 million in cash through an equity bought deal. Capital raised places us in a stronger position with more optionality in the method we continue to use to continue to deleverage. We are committed to driving our leverage ratio below four times net debt to adjusted EBITDA, including the converts, as quickly as possible. The business is stronger today as a result of these transactions.
During the second quarter, we also launched a strategic review of our non-core assets to expedite our priority to de-leverage. The review is examining a variety of options and is ongoing. I am required to say that no assurances can be made that that strategic review will result in any specific transaction or additional actions, but I assure you we’re committed to the process and will continue to work through the review to identify and close on the best outcome for our shareholders.
Free cash flow performance and cash flow conversion are priorities for the business in 2024 and beyond. Last quarter, we announced a plan that targets $70 million or more of free cash flow performance improvement by the end of Q3 fiscal ’24, compared to Q1 fiscal ’24. We’re on track to meet this target with a $40 million improvement on an annualized basis in Q2. This improvement was primarily due to price optimization, a reduction in capex, an improvement in restructuring and other costs, and lowering adjusted operating costs.
We have made material progress in diversifying the business over the past 24 months. We’re a legal technology company that supports law firms to manage and grow their practices faster with less effort. We’re not a real estate company. Our exposure to Canadian real estate continues to shrink and now stands at just 19% of total revenue, and we have even less exposure than that to resale transactions when you take into account re-financings. To put it into perspective, some software companies have customer concentrations that are higher than that figure. Revenue driven by global real estate transactions that law firms are working on was 44% in the quarter – that’s great progress towards our goal to drive that figure down to 33% of total revenue within three years.
I also want to take a second to talk about our board refresh. We added two new directors at the end of last year, Colleen Moorehead and Peter Brimm, and we’re excited to have them on board and to bring their capabilities and skill sets with them. I’d also like to say thank you to Mario Di Pietro, who served on the board for many years. We wish Mario all the luck in his future ventures.
The business is in a great position today with the launch of the global Unity platform, a more diversified revenue base, a strong and growing base of ARR, a strong balance sheet and improved capital structure.
I’ll now turn it over to Frank to discuss the financials.
Frank Di Liso
Thank you Matt, and good morning everyone. This morning, we reported our second quarter fiscal 2024 results. Our results continue to demonstrate the resiliency and diversification of the business.
As Matt mentioned, we continue to diversify our revenue base and enhance our practice management offering. We continue to reduce our reliance on real estate transactions and increase our annual recurring revenue primarily through our practice management solutions. This quarter, we’ve included a new metric, annual contracted revenue, which further demonstrates the consistency of the business.
Revenues exposed to real estate transactions globally in Q2 was 44% compared to 54% in the same period of fiscal ’23, while revenues exposed to real estate transactions in Canada was only 19% compared to 30% in the same period of last year. Keep in mind that a portion of our 19% exposure in Canada includes re-financing transactions which, when excluded, would further reduce this metric.
Annual recurring revenue contracted was 27% as of December 31, 2023 compared to just 16% at the same point last year. There are components of our revenue which we do not include in ARR, such as revenue from contracted overages and other revenues under contract with service agreements. Annual contracted revenue in the second quarter was 49% inclusive of ARR.
We reported revenue of $110 million during the second quarter, an increase of 17% compared to the same period last year and taking into consideration the sale of TM Group on August 3, 2023. Revenue grew 3% year-over-year, including the impact of TM in the prior period. Keep in mind that the Q2 and Q3 periods of our fiscal year are typically the weakest from a seasonality perspective. Q4 and Q1 in that order are typically our strongest seasonal periods.
We generated adjusted EBITDA of $60 million in the second quarter of fiscal 2024, an increase of 9% or $5 million compared to the same period last year and taking into consideration the selling of TM Group. Adjusted EBITDA grew 4% or $2.4 million including the contribution of TM Group in the prior year. The improvement is primarily a result of the growth in revenues, both organic and inorganic, as well as the early impacts from our business improvement plan. We continue to maintain our strong EBITDA margins, coming in at 54.5% this quarter, which is in line with our target range of 50% to 60%.
Total adjusted operating expenses, which includes direct costs, technology costs, G&A, and sales and marketing were $50.2 million for the quarter, or 44.5% of revenues. We expect our ongoing operating costs to be within the 40% to 50% range of revenues. Net of the impact of expenses from our last 12 months of acquisitions and the sale of TM Group, our adjusted operating expenses for the quarter were lower by approximately $1 million from the prior year, which demonstrates the improvements from our business improvement plan announced in the previous quarter.
As we acquire assets and manage the broader business, we continually look for ways to drive cost synergies and eliminate redundancies. Net finance costs for the quarter were $49 million compared to $38.4 million in the same period of fiscal ’23. The increase was mainly due to an increase in interest rates, higher debt balances, as well as unfavorable non-cash impacts from the change in fair value of our convertible debentures as compared to the prior period.
Acquisition, restructuring and other costs for the quarter were $5.3 million. This was a decrease from $15.6 million in the second quarter of fiscal ’23, and we believe we can deliver additional improvements in this cost line item over time.
We’re taking actions to increase our cash flow performance and placing a greater emphasis on this measure. Our Q2 cash flow from operations was $44.6 million in the quarter, up 57% compared to the same period last year, and an improvement in free cash flow of $9 million as compared to the previous quarter.
Turning to our balance sheet, our net debt excluding the convertible debentures stood at approximately $1.05 billion as of December 31, 2023. Subsequent to the end of the period, we increased the size of the substantial issuer bid that Matt talked about earlier and closed the equity bought deal financing, which raised net proceeds of approximately $140 million, which was partially used to retire all of the outstanding revolving facility as at December 31, 2023.
We understand the importance of reducing our leverage ratio and we have set a clear target to reduce it below four times total net debt to adjusted EBITDA. That said, we have sufficient resources to manage our debt levels. The business generates strong, sustainable cash flows.
We’ve built a business of scale that is mission critical to small and medium sized law firms and financial institutions. Today’s results and the recent actions we’ve taken demonstrate the consistency of the business and the opportunity in front of us.
With that, I’ll turn it back to the Operator for Q&A.
Thank you sir. Ladies and gentlemen, we will now begin the question and answer session. [Operator instructions]
We have our first question coming from the line of Robert Young from Canaccord Genuity. Please go ahead.
First question from me would be related to the delayed draw – it looks like you drew down on that in the quarter, and then you said that you were going to use proceeds from the recent deal to pay down the revolver. Does that include the delayed draw or do you think of the revolver as separate, and what’s the reason for the draw down on the delayed draw?
Frank Di Liso
Hey Rob, it’s Frank here. Yes, as I mentioned, we didn’t draw down on the delayed draw, we have it as a separate facility as compared to the revolving credit facility, so we completed eliminated the balance of the revolving facility that was outstanding. As you recall, it was approximately $30 million at the end of December 31.
Okay, and then maybe if you could talk about the focus on deleveraging and what happens after you reach four times leverage. Maybe you can just talk about how you view the strategy once you hit that level.
Look Rob, I don’t think our strategy has dramatically changed. The business continues to generate a lot of cash. We’d like to–obviously having less debt internal, so paying less interest enables us to redeploy that cash to continue to grow, and that’s what our plan’s going to be.
If I could just ask in a slightly different way, if the deleveraging goes a little faster than people expected, will you continue to focus on deleveraging? Is that going to continue to be important, or will you shift more to more M&A?
We’ll continue to grow the business.
All right. Then maybe last question from me, you talked a little bit about ARR expansion – I think you said that you’d started in the U.K. and Australia last quarter. Maybe just talk about the areas of growth in the near term, dominated by Canada to date, but how far are you able to expand that?
We’ve rolled out our ARR sales effort in the U.K., and despite it being early days, we’ve seen great traction from the numbers of customers taking up contracts. Again, we’re going in with a cross-sell between our data and insights business and our practice management business, and it’s being very well received despite it being early days.
Okay, that’s all from me. Thanks.
Our next question comes from the line of Thanos Moschopoulos from BMO Capital Markets. Please go ahead.
Hi, good morning. It looks like you acquired Credus [ph] during the quarter. Can you provide some color on that business – is that an ARR type of business and more transaction-driven, and is there a technology you can leverage in other geographies or is it primarily U.K. specific technology?
It’s a client on-boarding tool that’s used today primarily in the U.K. It has large market share in that market, and we are looking to, depending on the needs of the market, every market has different KYC needs and they’re not just country needs, they’re on a state-by-state, province-by-province basis, and so we’ll continue to–we are looking at other markets where that technology can be leveraged. But when launched the Unity global platform, we already integrated and white labeled Credus as the Dye & Durham solution for our many, many law firms that spend their days inside our platform already.
Okay, and can you provide an update regarding the strategic review of the Canadian financial infrastructure business, or is there not much you can say on that front?
I said what I’m allowed to say, or what I’ve been advised I should say at the beginning of the call, but we do remain committed to seeing where that process goes.
Fair enough. Last one from me, just given that there seems to be signs of life in property transaction volumes, at least in Canada, and just heading into the upcoming quarter, is it safe to assume that we should expect to see some sequential uptick in the business in both revenue and EBITDA, recognizing you don’t provide guidance but just directionally?
We sell software to law firms. It’s hard for me to comment on the real estate market.
Frank Di Liso
Maybe I’d just add, we do disclose the real estate exposure metric, Thanos, so right now for Q2, it’s at 19%, and that includes refinancing transactions, so as we continue to bring customers on board with minimum subscription volumes, our exposure will continue to decrease.
And Thanos, I think I would just reiterate, we have sub-20% of your revenue today is coming from lawyers working on transactions that involve real estate in Canada, so we’ve dramatically diversified the business. I think I just wanted to reiterate that.
Fair enough. I’ll pass the line, thanks.
Our next question comes from the line of Kevin Krishnaratne with Scotiabank. Please go ahead.
Hey there, good morning. Just a quick question on the ARR – 27%, I think that was kind of flat from last quarter. Can you explain why that may have been the case? Was that within expectations, and any ways to think about targets of where that could go over the next couple quarters?
Frank Di Liso
Yes, in terms of targets, Kevin, we are committed to seeing ARR grow to 15% over the next two and a half years, so we’ve recommitted to towards that, and now that we’ve added a new metric on annual contracted revenue, that will always be one step higher than our ARR metric. We have obviously in our results [indiscernible] only factor that wouldn’t impact ARR, which was the main reason why you’d see a flat amount quarter to quarter, and some other revenue adjustments that were made.
Okay, thanks for that. Interested on the contracted revenue, can you dig in a little bit deeper, maybe give us some examples, are those–you know, how are those structured, are they one year, multi-year, and any other color you can provide on that would be helpful.
Yes, generally – generally – our contracts are three-year contracts. Again, they generally have auto-renew clauses. There are some recent exceptions, we have some one-years, so we have a couple–not many, a few five-years, but generally they’re three-year contracts with auto renews, and a lot of them have price escalators built into them. When Frank talks about overages, there is–there’s really kind of three types of contracted revenue we have. There is per-user, per-month contracts over three years, so your traditional subscription ARR contract. There is minimum spend contracts, some people refer to as take-or-pay contracts, and then we have the overages on those take-or-pay contracts if they go over.
In that other category in which I’m counting overage, we also have contracts where we are suppliers particularly for big banks. We offer a service, often exclusively or exclusive-like, that we provide on their behalf and we often charge transactionally for those services that we provide on a contract, so that’s what we capture in the other bucket.
Got it, okay, so that would be the payments, Telus Financial sort of business would be kind of captured in there?
Yes, Australia we do the same thing, so banks–so it’s a combination of those supplier contracts we have for banks and the overages on our minimum spend contracts. Those two buckets are what we count as other.
Got it, okay. Cool.
The last one from me, if I try to think about free cash flow and I take your EBITDA, deduct the interest, cash tax, working capital I think was softer again in the quarter. You get close to sort of flat on that basis, but as we look forward, I know you said capex, what are some of the other drivers that give you the confidence in this underlying free cash flow growth? How do we see working capital normalizing in the next few quarters?
Frank Di Liso
Yes, so you’ve got the main drivers correct, Kevin, so working capital, you’ve got to remember that there were some spillover effects from the sale of TM that would have continued on into Q2, so there was a slight hurt there from the working capital side. But as Matt mentioned in his opening remarks, pricing optimization, a continued reduction of capex where we’ve only started that, we should expect more in Q3, as well as a continued reduction in our one-time charges, and as we continue to integrate the businesses that we’ve acquired over the last 18 months, there’s further opportunities for integration.
Great, I’ll pass the line. Thank you.
Our next question comes from the line of Scott Fletcher with CIBC. Please go ahead.
Hi, good morning. I’m wondering if you could give us some color on how much of the 17% growth ex-TM, if you could sort of break it into how much was from pricing versus contribution from M&A versus customer expansion. I understand you probably can’t share numbers, but if there’s any sort of directional buckets you could share, that would be helpful.
Frank Di Liso
Yes, so the 17%, as you correctly point out, Scott, it does exclude TM. We don’t disclose inorganic versus organic, and the simple reason, when we acquire companies, we don’t keep them status quo. We will look at their pricing model, we will up-sell their customers to our products, and so the vast majority of the growth that you’re seeing year-over-year is that effort of up-selling customers, putting them into contracts, optimizing their pricing structure, and that’s what’s largely–and there were also some increases in our Canadian financial institution services, as well as our daily insight products in Canada that also performed well year-over-year.
Okay, thanks. Of those, you had spoken about pricing increases coming through in the quarter across a number of the pieces of the business. Were those fully reflected in the quarter or is there–was there anything that might hit more in Q3?
Yes, some of them were fully reflected in the quarter, but there were other elements, Scott, that we introduced in the middle of November, in which case you’d only see a month and a half impact in Q2, so there will be some more spillover impacts when you look at it on a full quarter basis, which will be Q3.
Okay, thanks. Then I just wanted to ask one question on the remaining 2026 converts that are outstanding. I think we all understand that there’s an intention to deal with those. Would another buyback take a similar shape if you were to take that approach? Would it be sort of a refinancing and additional issuance, or does the equity raise change the calculus there, just potentially more cash considerations?
There’s a few ways to deal with it. I mean, hypothetically you could do what you said – you could offer to buy them back either through a combination of cash or terming out–you know, offering a new convert, in essence. Our leverage levels are also potentially getting to the level we could refinance our debt, so you may be able to refinance through a credit facility. We do not have a spring maturity, which you could leave it outstanding or also buy it back. We’re exploring all options.
We take deleveraging seriously. We take having a lower cost of capital seriously. One of the best ways to build value is to have the lowest cost of capital possible to generate the most cash we can on the business, and one of our biggest expense lines, or our biggest is interest payments today, so to the extent we can reduce that, that’s good for the company, good for the equity holders, good for business.
Okay, thanks Matt.
Thank you. There are no further questions at this time. I would now like to turn the call back over to Mr. Hirji for final closing comments.
Thanks to all for attending, and we look forward to connecting with you during the Q3 results call in May. Have a great day.
Thank you sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.