Dye & Durham Ltd

TSX:DND

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon. My name is Colin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Dye & Durham First Quarter Fiscal 2023 Earnings Call. I would now like to turn the call over to Ross Marshall, Investor Relations, on behalf of Dye & Durham. Mr. Marshall, you may begin your conference.

[Ross Marshall]

Thank you, operator, and good afternoon, everyone. 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 and opportunities.

Such statements are made as of this date hereof, and Dye & Durham assumes no obligation to update or revise them to reflect the events, disclosures or circumstances, except as required by applicable securities law. 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 and future-oriented financial information section of our public filings without limitation, our MD&A, 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 with the formal results for research analysts.

I now turn the call over to Matt for opening remarks. Matt?

[Matthew Proud, executive]

Thanks, Ross, and good afternoon, everybody. Our business continued to perform well during the first quarter despite an extremely challenging real estate market, particularly in Canada. We've built a business that's diversified across 3 geographical markets and across various product lines.

I'm often asked how resilient is the business in the face of deteriorating real estate market. Real estate transaction volumes have come under significant pressure, especially in Canada since December 2021. Inflation is up and high, and it's going to remain high for a while, we believe. And we've seen the fastest increase in interest rates since the 1970s.

In Q1, we reported a good quarter despite these challenging headwinds. This afternoon's results demonstrate the strength of our underlying business with more than $120 million in revenue during the quarter and $64.4 million of adjusted EBITDA. We delivered this consistent performance in the face of monthly year-over-year real estate transaction volumes in Canada, which are down between 25% to 32% in the July to September period.

One of the reasons for the resiliency of the business is our revenue exposure to the global real estate market, which is at 68%. Only 68% of our volume is exposed to real estate transactions. 1/3 of the business globally is not directly tied to real estate transaction volume. Narrowing in further on our largest market, Canada, 43% of our revenue is exposed to the Canadian real estate market. While still significant in both cases, what we often see is modeling the signs of real estate transaction growth rate or decline in Canada across the entire business. And this is a vast oversimplification of the business in our view.

We've done a good job of managing through the deteriorating market transactions with increase in the price per unit, EBITDA we buy and synergies we realize in acquired businesses with the capital we deploy. Remember, a lot of our model has to do with capital allocation.

Touching on the [indiscernible] market. I've always been a large believer in running a business with operational and financial discipline. This is more important than ever right now, given the macroeconomic environment remains extremely challenging and continues to deteriorate in many cases. As such, I've decided the company to act more aggressively and decisively to protect its business and financial position. Therefore, we will be implementing cost reduction initiatives to reduce the current operational cost by at least 10% commencing in the second quarter of fiscal '23, i.e., the current quarter. This is happening now.

We continue to execute on our strategy of disciplined capital allocation to build a business of scale through acquisitions and investment in our existing platform. These acquisitions and investments drive enhancements and new capabilities of the platform that improve efficiencies and productivity of our customers.

The business is dramatically larger today than it was at the time of IPO 2.5 years ago. We're building a global leader in the B2B software and services space that supports legal and business professionals. As you can see, we built a highly resilient business and a highly reliable business that generates digital infrastructure cash flows. The annuity nature of our revenue and the relatively fixed nature of our cost base, we've managed -- means we've managed in an extremely disciplined manner through the recent inflationary period. And this provides for tremendous levels of productivity in our revenue as well as adjusted EBITDA.

It also allows us to drive the high EBITDA margins we do because the revenue can scale dramatically without corresponding cost increases. Importantly, this afternoon, we announced $150 million substantial issuer bid or SIB. Given the capital markets dynamics, consistency of our business in the face of real estate headwinds and the strength of our balance sheet, we believe there's no better use of capital at this point, especially given the significant discount, some may even say silly discount in which we trade in the market given the scale of our business today.

The initial details of the SIB are present in the -- are presented in the earnings release. And once we're out of the earnings blackout, we will be providing more disclosure on the terms of the modified Dutch auction style bid. In addition to the SIB, we've also been using the normal course issuer bid we announced in September, which Frank will address in a moment regarding the details of that normal course issuer bid. Underpinning our entire business strategy is disciplined and effective capital allocation. Look, we've demonstrated the ability over and over again to acquire assets, integrate them and scale them while maintaining strong margins. We believe this SIB is an extension of this capital allocation strategy.

So what does this mean as it relates to future acquisitions? We can walk and chew gum at the same time. We believe our recessionary environment will lead to stronger opportunities for additional M&A in the long term, which is a tailwind for our business. We're to come out of this stronger. As you can see in the Link administration disclosure, we're in discussions with them to acquire their corporate markets and BCM business. We would retain their BCM business and then look to divest the majority of that business in due course. We believe their corporate market business is an attractive asset that would further diversify our business, both by product line and geographically. It's also a business that does well in a higher rate environment, which would be very complementary to ours.

As of today, we have no further updates on the state of those discussions, and there's no certainty this deal will close as with any M&A deal. In parallel with the SIB, we're moving forward with our strategy to continue to diversify our core business with new acquisitions that address workflow inefficiencies, needs of professionals and legal market. As part of the strategy, we intend to continue to expand our market reach and entering adjacent ecosystems in Canada, the U.K. and Australia through acquisitions. Our pipeline remains very, very strong. As we've demonstrated through multiple market cycles, we're able to manage the business for consistent and substantial performance -- sustainable performance.

And we continue to execute our strategy of scaling through acquisitions, rapidly built a business that generates strong top line growth in an industry that provides stable cash flow and a very healthy margin, I wouldn't say so. We look forward to updating you on the progress as we move forward.

I'm now going to turn it over to Frank to review the financials. Frank?

[Frank Di Liso, executive]

Thank you, Matt, and good afternoon, everyone. Thank you for joining us today. This is my first time participating in the call. While I've only been here for a few months, I'm excited to be part of the team. We've seen strong growth in the business, their operating capabilities and the established cost management practices they have in place.

We reported revenue of $120.2 million during the first quarter, an increase of $7.5 million or 7% from the same period last year. We generated adjusted EBITDA of $64.4 million, an increase of $2.1 million or 3% in the same period last year. We continue to maintain our strong EBITDA margins coming at 54% this quarter, which is in line with our target range of 50% to 60%.

Top line growth has been fueled by both the acquisitions we've completed along with integration activities and our organic growth, which indicates -- which includes the realization of synergies from price adjustments. In the face of rapid inflation, we have maintained strict controls on the cost structure. We have a disciplined practice of managing costs as demonstrated by essentially coming in flat on a sequential quarterly basis.

Total operating costs, which include direct costs, technology, operations costs and G&A and sales and marketing, were $55.7 million for the quarter or 46% of revenue compared to $50.2 million for the quarter of the prior year. Included in the operating cost is a cost increase related to implementing a new IT managed service platform of $0.7 million to help streamline the business. We do not expect this cost to continue going forward.

The increase in other operating costs in the year-over-year period is due to costs acquired from acquisitions completed during the period. We expect our operating costs to continue to be within the 40% to 50% range of revenues. Net finance costs for the quarter were $16.2 million compared to a negative $12.6 million in the first quarter of the prior year. The increase is due to high interest and accretion expense of $18.3 million relating primarily to the Ares Credit Facility as well as the recognition of noncash gained on the change in fair value of convertible ventures of only $9.1 million compared to $15.3 million in the same period last year.

As a reminder, IFRS accounting rules required us to mark-to-market or fair value of these instruments each quarter, so we do expect this variability in our finance cost to continue. Acquisition, restructuring and other costs for the quarter were $18.5 million compared to $10.6 million in the first quarter of last year. The increase is due to $11.4 million in higher acquisition costs, primarily due to the Link transaction activity and $1.8 million in higher restructuring costs compared to the same period last year. This was offset by $3 million in privatization costs not incurred in the current period and $1.3 million decline in integration costs.

We built a resilient business. On Slide 8, you can see the growth that we have delivered on our adjusted EBITDA in the last 12-month period. We've managed puts and takes through this period to deliver consistent performance. Despite lower real estate market transactions, our adjusted EBITDA performance remained strong. It's a great example of how we can manage the business through cycles while we deliver shareholder value. Our conversion to adjusted EBITDA to cash flow was strong. We reported net cash provided from operating activities of $41 million in the quarter, an increase of $8.1 million or 25% compared to the same period last year.

Subsequent to quarter end, we announced the normal course issuer bid, which Matt referenced earlier. We have purchased and retired 2.8 million outstanding shares at this current stage under the program, which represents $46.2 million in capital deployed to shareholders. As of September 30 of this year, we have over $500 million of liquidity for the SIB and new acquisitions. Liquidity consists of cash, the revolving credit facility and the delayed draw term loan.

Our leverage ratio on a net basis is currently 2.5x as of September 30, which we believe provides sufficient headroom with our strong cash flow -- free cash flow conversion of 50% plus. We intend to deploy that capital towards new acquisitions and the current capital repurchase programs, as Matt mentioned earlier. Earlier today, our Board approved a quarterly dividend of $0.01875 per common share payable on November 23 to shareholders of record November 16.

This concludes my formal remarks. And with that, I would like to turn it back to the operator for Q&A. Operator?

[Operator]

[Operator Instructions] Your first question comes from Robert Young from Canaccord Genuity.

[Robert Young, analyst]

Okay. For the substantial issuer bid and just that's in addition to the previous NCIB. I think in the release, you said you're no longer going to work the NCIB. What is the total outflow across the approximately $200 million. Is that correct?

[Frank Di Liso, executive]

So Rob, it's Frank here. There's the $150 million for the SIB, and then we've already deployed $46 million of the NCIB. So there's roughly a small portion remaining there. But what's really standard now is the SIB with that smaller portion to come later.

[Robert Young, analyst]

And then post that, if you're going to pursue a transaction for Link CM business, presumably you'd need additional funding for that. Can you just give us a sense of what the comfort around leverage ratio is to make that transaction successful?

[Matthew Proud, executive]

It remains high, Rob, very high. Look, we're in a lucky state. We're a business that still has very strong performance. We produce a lot of cash and have a lot of EBITDA. And you're seeing even despite challenging markets, that performance continues. So look, as we always said, we're willing to take the leverage up temporarily as long as we bring it back down to that 2 to 3x range fairly rapidly, again, which we've consistently demonstrated ability to do.

[Robert Young, analyst]

In your prepared comments, you were focused on Canada, the real estate market there. Maybe you could just talk about Canada, the United Kingdom, Australia. Like what are the relative transaction volume impact from the macro issues we're seeing today? Just give me an update, more color on those markets, that would be great.

[Matthew Proud, executive]

Yes. I mean, our volumes generally trend with the data you'll see to come from the various market sources in that market, and we're seeing volumes trend almost exactly in line with that. Obviously, we have changed our PPU across all geographies upwards, which is helping with the downward pressure and leaving it. So that's been a big offset, the increase in PPU to the volume decrease. And then, of course, there's obviously the nonreal estate part of our business that's not impacted.

[Robert Young, analyst]

PPU is price per unit?

[Matthew Proud, executive]

Correct, yes.

[Robert Young, analyst]

Okay. Last question from me, and I'll pass it over. Just give us a little more detail around the 10% cost reduction. How do you plan to achieve it? Maybe just give us a sense of where that's coming from? Are you shutting down any businesses or some more color there would be helpful? And then I'll pass the line.

[Matthew Proud, executive]

Yes. Look, the largest cost we have is people, so we'll be letting people go. In addition to that, we'll look for efficiencies across our business.

[Robert Young, analyst]

And is there anything more you can elaborate on efficiencies? Like what type of efficiencies are you looking?

[Matthew Proud, executive]

Yes. Unnecessary vendors we have or opportunities to get a better price from vendors, nice-to-have stuff, discretionary spend. But obviously, the largest cost will come from the reduction of people. Again, we believe that we can reduce cost by that much without damaging the business.

[Robert Young, analyst]

And Frank said in the prepared comments that free cash flow as a percentage of revenue margins are 50% roughly. Is that the target to maintain that level? And then I'll pass the line.

[Matthew Proud, executive]

We'd like to be higher. Obviously, there's acquisitive costs in there that are pushing that down, particularly with Link in the last 2 quarters where it's been quite substantial. That was a very -- the control transaction was very expensive. So that won't continue going forward.

[Operator]

Your next question comes from Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos, analyst]

Just to expand on the OpEx reduction. I think you still have maybe some cost synergies from prior M&A that you're capturing. So does the 10% reduction include some of those cost synergies? Or are there incremental cost synergies from integrating things that could be added at that 10% reduction?

[Matthew Proud, executive]

We're not breaking out the 2. I think what you should be looking for is at least a 10% reduction on what our current OpEx is in the coming quarters. We're going to look to execute on that this quarter and anticipate, you'll see most of that in the following quarter coming out.

[Thanos Moschopoulos, analyst]

Okay. A typical rule of thumb from restructuring charge would be, I guess, taking the cost savings and annualizing it. Is that -- would that be fair? Or how should think about the restructuring charge required?

[Matthew Proud, executive]

No, we don't do that. When you look at our restructuring cost, it will be things like the onetime cost of making something redundant, severance. We're not taking the cost that, hey, we got rid of $100 of cost, and therefore, there's $100 [indiscernible] restructuring the line item. It's just the cost of removing that expense that gets restructured.

[Thanos Moschopoulos, analyst]

Okay. Any update on the TM Group divestiture?

[Matthew Proud, executive]

The process is underway, and that's all I can only say.

[Thanos Moschopoulos, analyst]

Maybe one last one from me is in terms of the parts of the business that aren't tied to property volumes, just to confirm, have those been holding steady? Has there been growth? Has there been any macro pressure? How would you characterize what volumes are doing in the rest of the business?

[Matthew Proud, executive]

It's been pretty steady. I mean, obviously, we -- yes, business as usual is best to describe it.

[Frank Di Liso, executive]

Thanos, we did update the MD&A, you would see in the quarterly metrics section that we have included those percentages driven by real estate transaction over the last 8 quarters. So you'd be able to see that if you had a look through.

[Operator]

Your next question comes from Stephen Boland from Raymond James.

[Stephen Boland, analyst]

Just one question. You withdrew the guidance for the year, citing conditions. But what are you seeing, like what's your view in terms of conditions this quarter that it's ongoing, but the next couple of quarters, do you see things leveling out here? Or what are you hearing from your vendors and your customers in terms of what their expectations are?

[Matthew Proud, executive]

Look, I think we're seeing over that was worse from a market perspective than September, which we were hoping it wouldn't be the case. And given the volatility we obviously don't control what the market does.

We just -- we'll be very prudent, and as such, remove that guidance. Look, it's hard to put through [indiscernible] market. So what are we doing? We're doing things like to diversify our revenue to ensure we have less exposure real estate, reduce cost as the business continues to perform.

We always look to flex the pricing power we have in our business through inflationary times to make sure we're operating with an optimal cost structure and charging the right amount for our products. So those kind of things we're doing.

[Stephen Boland, analyst]

Okay. And second question, actually, just in terms of -- I know you're always looking at acquisitions. Have you seen multiples come down over the past -- excluding Link, but I mean there are other acquisitions out there and targets, have you seen multiples come down from their side at all or materially or anything like that?

[Matthew Proud, executive]

I mean, what we see in the public market is -- I mean [indiscernible], obviously. But putting that aside, on the private side, we are starting to see a softening in multiples. There's still a bid-ask spread between buyer expectations, seller expectation, but it's starting to move in the favor of buyers and becoming more buyers' market. That's absolutely a trend we're seeing.

[Stephen Boland, analyst]

Okay. And would those multiples mean back -- even a couple of years ago, you were talking about high teen multiples. Are these multiples like moving into single digit? Or are they 10x or anything like that? Like is it still kind of...

[Matthew Proud, executive]

It's still very -- it's too early to put a trend on exactly where it is. I saw some data recently, looked at kind of LBOs in U.S. being just under 11x, just under 12x on the multiple. It really depends on the business and the various -- higher-quality businesses will demand higher multiples. But across the Board, we are seeing it decreasing. I wouldn't yet put it where you put it in single digits, but it's getting close.

[Operator]

Your next question comes from Kevin Krishnaratne from Scotiabank.

[Kevin Krishnaratne, analyst]

I've just got one question. So real estate transactions and how they're trending is out of your control, but things like pricing and new product intros are within your control. Can you just talk about your -- the opportunities there?

You are reducing costs. I'm just curious to know whether any of the reductions, how to think about the potential impact that might have on your growth strategy? I know that there's different products you're thinking about, the TELUS product, there's a subscription product. Can you just walk us through your thoughts there?

[Matthew Proud, executive]

Yes. Look, we continued in Canada on our workforce offer product to introduce subscriptions to help protect on market declines. Look, we would still invest more than anyone else in the industry on R&D, fairly [indiscernible].

I think this is an organization, culturally, we're big believers in doing more with less, small lean teams that are highly focused and get a lot done, sometimes more so than a bigger team that's not lean. So harnessing that strength to make sure we prioritize if things are important to our customers into the market and put in the back burner the more the nice-to-have things. So it's a philosophy we've always used, and I think we'll continue to use it and must rely more through times of scarcity.

[Kevin Krishnaratne, analyst]

Okay. And just maybe looking across all your geographies, products, any shift at all from -- competitively, I know you've got pretty good share. You've got a leading product, so likely not, but just curious to see if you're seeing anything even just on the fringe there popping up?

[Matthew Proud, executive]

No, not really. I mean, it's pretty -- I mean, churn is very stable. The business -- we're not seeing a lot. We have a really good market position.

[Operator]

Your next question comes from Scott Fletcher from CIBC.

[Scott Fletcher, analyst]

Most of the questions have already been covered off here. So I'll ask maybe a question on M&A and if this new cut of the Link deal does go through, it would seem like you would have to take a sort of a pause after that. Is that still the -- is that still your preferred approach to M&A sort of like these bigger deals? And then wait to bring -- wait until leverage comes back down? Or is it just a -- was it just the opportunity that came up?

[Matthew Proud, executive]

Look, I mean, integrating a small transaction is many cases, just much work, and if you do 10 small ones, it's a lot -- even more work. Look, as you've seen for us, we would prefer bigger, chunkier deals where we can have a clear path to our return multiples.

And obviously, we see that in this transaction. Yes, I can't really speak about it beyond that. But I hope that answers your question.

[Operator]

Okay. That's all the time we have for questions today. I'll now turn it back to Ross for closing remarks.

[Ross Marshall]

Thanks, everyone, for joining today. We look forward to updating you with Dye & Durham's Second Quarter Fiscal 2023 results in February of 2023. Good night.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.