Dye & Durham Ltd

TSX:DND

Earnings Call Analysis

Earnings Call Transcript 2024-Q1

[Operator]

Good afternoon, ladies and gentlemen. My name is Jenny, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dye & Durham First Quarter Fiscal 2024 Earnings Call.

I would now like to turn the call over to Ross Marshall. Ross, Investor Relations on behalf of Dye & Durham. Mr. Marshall, you may begin your conference.

[Ross Marshall]

Thank you, Jenny, and good afternoon. Welcome to the Dye & Durham earnings 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 indicates management's expectation of future growth, results of operations, business performance, 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 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 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, Chief Executive Officer; and Frank Di Liso, Dye & Durham, Chief Financial Officer. A question-and-answer session will follow the formal remarks for research analysts.

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

[Matthew Proud, executive]

Thanks, Ross, and good afternoon, everybody. The business performed extremely well in the quarter, which was our second best in terms of adjusted EBITDA and third best on a revenue basis. Adjusted EBITDA also outperformed on a sequential basis. In addition to that, in the quarter, we paid back $45 million in net debt.

Our core business is doing very well, and its performance underscores the strength and consistent ability to generate cash flow to fuel our growth and finance our operations.

We heard investors in reducing our leverage ratio is a priority for us. Our aim is to bring the business down to below 4x total net debt to adjusted EBITDA as soon as possible. And we're looking at all available options to help us achieve this goal.

As I mentioned, in the first quarter, we reduced our debt by $45 million, and we're focused on growing earnings and increasing our cash flow conversion to continuously pay down debt, making significant improvement to our free cash flow performance is also a top priority.

To that end, we've launched a business performance improvement plan, targeting improvements of greater than $70 million in free cash flow performance to be realized by the end of Q3 fiscal '24 on an annualized basis compared to Q1 fiscal '24, i.e., the current quarter.

In October, we've already actioned $40 million of annualized improvements towards this target with the full benefit of this action being realized in Q3 of fiscal '24.

We're implementing a series of measures to achieve this goal, including a reduction in capital expenditures, price optimization and further reducing onetime charges as we are lowering and lowering our operating costs.

As you recall, over the past 2 years, we made a dedicated effort to diversify our business and focus it on the legal practice management software market. We've had -- we've made meaningful progress in this regard, which has put us in a much stronger position today and made the business stronger

off.

The impact of real estate on our business, to be honest, is quite misunderstood. To be clear, we sell SaaS software to law firms to help them grow and efficiently manage their practice. This software is mission-critical to legal professionals [indiscernible], if they're conducting real estate transactions or not.

To quantify this, the downside risk to Dye & Durham for the entire Canadian real estate market was only 27% of total revenue in the first quarter.

We view this as comfortably manageable, especially when you consider that some businesses have revenue concentration of more than 20% in the hand of a single customer, not an entire end market.

Shifting our focus to selling practice in the software has served to improve and diversify our business, including increasing our annual recurring revenue. ARR was $117 million as of September 30, 2023. That's more than double what it was at the same time last year and represents high quality revenue growth across our full portfolio of software solutions.

ARR is 27% of our total revenue compared to basically nothing when we started 2 years ago, and we're making meaningful progress towards our target of 50%. Our ARR today is made up of 2 broad categories: the first team with gold standard per seat pre-user revenue and the second being minimum spend contracts.

We continue to be very disciplined and thoughtful though our pricing strategy. During the quarter, we announced a variety of price changes across our global portfolio. In some cases, to offset higher input costs due to inflation and in other cases, to bring our prices in line with other market providers. Case in point, today, we're arguably the largest provider of legal practice management software in the United Kingdom and Ireland, thanks to our recent acquisitions. However, the per seat per user price for our practice management software solutions being offered is still significantly lower than market. We're in the process of addressing this over the remainder of fiscal '24 across more than 20,000 users in that market. And at a high level, we believe that price can consistently contribute roughly 10% annual growth to revenue.

At the same time, we've also improved our cash conversion. You started to see this in Q4 fiscal '23 results, and we continue to make progress in Q1 fiscal '24 with approximately $6 million in acquisition and restructuring add-backs that were cash based.

We believe we can continue to show improvement in this area. We believe for a business of our scale with $250 million or more in adjusted EBITDA, that's a reasonable goal and reducing charges of $10 million to $15 million on an annualized basis over time, which will free up more cash flow for our capital allocation priorities. It's really a healthy business.

Our payments infrastructure and banking technology business also performed well in the quarter. It's a business that has a lot of upside in it, and we're seeing significant growth. It offers best-in-class digital infrastructure to most major Canadian Australian lenders, providing critical technology and products, which support essential functions like payments, information services, property settlement and core banking infrastructure.

This business has trusted long-term relationships with more than 95 lenders and financial institutions. It represents an opportunity for us to generate more cash in the near term.

To build this momentum, we're working to further professionalize the management team in that business and hire a new CEO for that business. We're also looking at ways to highlight the value of this business better to investors in the coming quarters.

Before turning it over to Frank to highlight the financials, I'll briefly address the recent convertible debenture transaction. The terming out of approximately 1/3 of our convertible debentures by 2.5 years or 5 years of runway in total in a highly undiluted piece of paper that only increased the yield to maturity by 2.4% and a nominal amount of increased cash interest of $2 million when looked in the aggregate was the right move for the company. I talked to some people who look at only one side of the trade and say it's expensive.

We believe both sides of the trades should be considered to draw a fair and accurate conclusion. We believe it was the right trade for the business that reduces the comparable debt and reduces risk on our overall capital structure.

Without a doubt, it's been a challenging few weeks for us. I understand that shareholders are frustrated. We are frustrated too, but our interests are aligned with yours.

Today's results demonstrate the improved performance of the business delivered in the past quarter and show our strategy is working. We believe we have all the ingredients to build on from here. We operate a differentiating global business with a large diversified customer base of small- and medium-sized law firms with a sticky best-in-class practice management offering that is mission critical to customers.

I'll now turn it over to Frank to review the financials.

[Frank Di Liso, executive]

Thank you, Matt, and good afternoon, everyone. This afternoon, we reported our first quarter fiscal 2024 results. Our results continue to demonstrate the resiliency and consistency of the business independent of market cycles and ability to generate cash flows. Our diversification strategy and build-out of our product management solutions are working.

We continue to increase our annual recurring revenue contracted and reduce our exposure to real estate transactions. Annual recurring revenue contracted was 27% as of September 30, 2023, compared to just 13% in the same period last year. Revenues both from real estate transactions globally in Q1 was 49% compared to 62% in the same period of fiscal 2023. While revenue exposed to real estate transactions in Canada was only 27% compared to 37% in the same period of last year. We reported revenue of $120.1 million during the first quarter, which is in line with the same period in fiscal 2023.

In that prior period, there was an additional $9.3 million of revenue from TM Group, which was divested on August 3, 2023. Excluding the impact of TM Group, revenue has grown by more than 8% in the first quarter of fiscal '24.

We generated adjusted EBITDA of $68.7 million in the first quarter of fiscal 2024, an increase of $4.3 million or 7% compared to the same period of fiscal '23. Our highest quarterly amount since Q4 of 2022. This is primarily a result of lower adjusted operating expenses and growth in revenue after taking into consideration of the TM Group divestiture.

We continue to maintain our strong EBITDA margins coming at 57% this quarter, our highest level since Q4 of 2022 and is in line with our target range of 50% to 60%. Total adjusted operating expenses, which includes direct costs, technology costs, G&A, sales and marketing, were $51.4 million for the quarter or 43% of revenues, an improvement of $4.3 million or 8% compared to the prior year period when total operating costs represented 46% of revenues.

Net of the impact of expenses from fiscal 2023 acquisitions, our operating costs for the quarter were $43.6 million, which demonstrates improvements from our cost reduction if it is implemented early in the second quarter of fiscal '23. As we acquire assets and manage the broader business, we continuously look for ways to drive cost synergies and eliminate redundancies. This is one of the methods to continually improve cash flow performance, which Matt addressed earlier.

We expect our ongoing operating costs to be within the 40% to 50% range of revenues. Net finance costs for the quarter were $35.1 million compared to $16.2 million in the same period of fiscal '23. The increase is due to an increase -- an increase in interest rates and higher net debt levels as well as lower favorable noncash 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 $6.4 million. This was a decrease from $18.5 million in the first quarter of fiscal '23. As Matt mentioned earlier, improving cash flow conversion is one of the paths towards driving down our leverage ratio below 4x. We believe we can deliver additional improvements in this cost item over time. We are targeting $10 million to $15 million acquisition, restructuring and other costs on an annualized basis.

You should expect continued improvements in the second quarter and beyond, as this is 1 component of our $70 million annualized business improvement plan mentioned earlier.

Now turning to our balance sheet. We reduced our overall debt by $45 million during the quarter, mainly with the proceeds of the sale of TM, and at the same time, this quarter, we closed small deals in legal process management space that we locked into in late fiscal '23.

Our leverage ratio based on fiscal consensus including the impact of the convertible debenture is currently 5.1x at September 30. We have sufficient resources to manage our debt levels. The business generates strong sustainable cash flows. So we understand the necessity to drive down our leverage ratio, and we have set a clear target to reduce it below 4x total net debt to adjusted EBITDA.

We're taking actions to increase our cash flow performance and placing a greater emphasis on this measure. Our Q1 cash flow from operations increased by 4% versus the prior year. We've built a business of scale that is mission-critical to small- and medium-sized law firms and financial institutions. Despite the challenging macro market conditions, today's results and plans demonstrate the resiliency of the business and the opportunity in front of us.

With that, I'll turn it back to the operator for Q&A.

[Operator]

[Operator Instructions] Your first question is from Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos, analyst]

Matt, maybe just to clarify regarding the focus on deleveraging. Should we be thinking that you'll be taking a pause on M&A for the next few months or to deleverage? Or would you still consider opportunities albeit more selective ways?

[Matthew Proud, executive]

Look, our main focus is we heard investors deleveraging as a priority. And look, as we deleverage, that will free up more cash flow that in the future will led us to get back to business. But we kind of heard the message loud and clear. So for us in the near term, and so getting that debt to adjusted EBITDA as a metric to look at below 4x ASAP. And look, we -- as you would have seen last quarter, there was -- aside from the [indiscernible] acquisition that was announced in the Q4 results, there was a couple of million dollars of very small acquisitions we did that were accretive given what we paid for them, but they were very, very small.

[Thanos Moschopoulos, analyst]

Okay. Now as far as your end markets, you have better real-time visibility than we do. The data gets a bit lagged. Is it still the case that we're kind of bouncing around the bottom? Or are you seeing any trends across your geographies?

[Matthew Proud, executive]

So I mean, look, our business is performing really well. If you consider that -- compared to Q4, we sold TM yet still came in sequentially with the same amount of revenues we have Q4, which is generally always seasonally slow, and that implies that our core business is doing really well.

Look, I assume your question relates to kind of real estate transactions, which are now a minority of our revenue. Look, we're still kind of -- if you look at kind of the numbers we see and kind of correlate with businesses we have that do track purchase and sales, yes, I mean, it's still a fairly depressed market out there.

But at some point, pent-up demand comes back. I mean that will be great upside in the future. But today, even without that, you're seeing great performance in the business as it is demonstrated by the results. We were able to kind of sell -- was about 16% of our revenue. And still, in a quarter is generally sequentially down kind of be flat over last quarter, which again speaks to the strength of the business. So I hope that answered your question.

[Thanos Moschopoulos, analyst]

Yes, it does. And then just as we think about the December quarter, just given seasonality in some of your markets, and given a bit of TM going away, I guess, would it be reasonable to expect that revenue and EBITDA will be down a little bit sequentially versus September quarter?

[Matthew Proud, executive]

Yes. Generally, we have -- our Q3 -- 2 is a bit softer than Q4 and Q1.

[Frank Di Liso, executive]

Thanos, Just remember that in Q1, we still had just a month left of TM revenue. So naturally that will fall off in Q2.

[Thanos Moschopoulos, analyst]

Maybe just to confirm that, I mean, from the disclosure, it seems maybe $16.5 million of TM revenue. Is that in the general ballpark?

[Frank Di Liso, executive]

Yes, in general, yes, that's a good number. But as I mentioned before, the year-over-year impact on revenue was $9.3 million. So that's 3 months compared to 1 month.

[Operator]

Your next question is from Kevin Krishnaratne from Scotiabank.

[Kevin Krishnaratne, analyst]

Just a question on the $70 million free cash flow. There's a number of categories that the benefits are coming from. Can you give us a sense of where the greater impacts are to come from with CapEx? Is it the product price changes, OpEx? Any color there?

[Frank Di Liso, executive]

Yes, I can take that, Kevin. So they are -- we have purposely put them in order of significance. So as you mentioned, the first couple being the reduction in CapEx would be something that we've already actioned and then followed by a reduction in onetime charges and then the price optimization initiatives that we have.

[Kevin Krishnaratne, analyst]

Okay. Got you. And then I thought I was interested in the comments you made on the opportunity in practice management, I think it was in U.K. and Ireland. I might have misheard, did you say 20,000 users there, there's an opportunity for an uplift there? Just curious to know how do we think about the level of that uptick? And then did you say going forward, you would think that, that's a business that you could do 10% increases year-over-year? I'm just curious about the commentary that you made there.

[Matthew Proud, executive]

Yes, it's Matt, Kevin. Look, it was kind of a case in point example of some of the upside we have in our business when you're just -- you're looking at business we have and your price points quite deeply below market. So it's not the case in point. We have 20,000 users that are paying in many cases, $100 a month below market, you kind of convert to Canadian dollars. That's just 1 example of some of the opportunities we have in the business. When you kind of back up and look at it kind of from when 50,000 feet, this is a business when you kind of look at all the opportunities that we have, every year, you can grow at kind of 10-ish percent. We've consistently said that for many years and in most cases, we've been delivering that.

[Kevin Krishnaratne, analyst]

Okay. Got you. The 19% ARR to 27% ARR in the quarter, it was a nice jump. Was that mainly driven by M&A and if -- and also how are -- how is progress being made on the minimum value contracts?

[Matthew Proud, executive]

It was driven by both. There was a [ proximated ] application acquisition in there that we talked about in our Q4 financials that would also be in these financials. But there was also a lot -- a lot of that was driven from kind of minimum spend contracts, particularly out of Canada.

[Frank Di Liso, executive]

Kevin, the increase is actually 13% to 27% year-over-year. But given that Q4 was obviously a high period, as Matt mentioned, there were a lot of contracts that were signed in Q4 that had a partial benefit in Q4. So you're getting the full 3-month benefit in Q1.

[Kevin Krishnaratne, analyst]

Sorry, I was -- did you not do -- is it 19% in Q4, right? So I was going from 19% in Q4 to 27%. Yes. Okay.

[Frank Di Liso, executive]

Correct. Yes. [indiscernible] year-over-year.

[Kevin Krishnaratne, analyst]

Okay. Last one for me, just on some cash items there. Number one, how do we think about cash taxes for the year. They were a little bit elevated, I think, in '23. Just wondering where they land in '24? It looked like it was pretty modest in Q1. And then the second one on cash is, can you remind us of any -- a rough estimate for holdbacks and potential earn-outs that you're going to be paying out in 2024?

[Frank Di Liso, executive]

Yes. So for cash taxes, we have implemented a series of plants in Canada to get a better handle of our uses of cash. And we do expect our reductions in cash relative to the fiscal 2024 amount. You should look at an effective rate of about 25%, but given that we have the large loss carryforwards of approximately $200 million, we do tend to implement a good use in the fiscal period in Canada.

And your question on holdbacks, we do have a disclosure in our notes about the total amount of holdbacks. So you can refer to that, Kevin. But off the top of my head, I think it's roughly around the $10 million to $15 million over the next 12 months.

[Operator]

Your next question is from Gavin Fairweather from Cormark Securities.

[Gavin Fairweather, analyst]

Congrats on the results. Just a clarification first on the $70 million free cash flow annualized increase. It sounds like you actioned about $40 million in the current quarter. Should we think about a lag to some of the benefits, both on the cost side and pricing side?

[Matthew Proud, executive]

Yes, that's right. So in the month of October, we actually got $40 million of it. And there's some more are going to come on in the rest of the quarter. So you'll see that impact happen in the results we released in February for this quarter. And then you'll see the full $70 million annualized impact on a quarterly basis next quarter.

[Gavin Fairweather, analyst]

Okay. Makes sense. And then in your prepared remarks, you talked about some of the pricing actions that you've been undertaking recently. I'm sure you're watching kind of revenue per customer and churn trends pretty closely. Are those kind of generally falling in line with your expectations? How would you describe that?

[Matthew Proud, executive]

Yes. I'd say everything is in line with expectations. I mean we have a -- churn is generally very low across the business. We have multiple products, in many cases, sold across the same customer, which generally leads to a sticky customer. And so there's a real focus on getting more customers on the contract, which even helps us reduce that more.

[Gavin Fairweather, analyst]

Next for me, you referenced the 4x above leverage target a few times. Would you be willing to put a kind of time line around that? Or any kind of thoughts on when that might be achieved?

[Matthew Proud, executive]

No, we're not going to commit to a time line today, let's do it ASAP. I would say though, like in the kind of longer term, we're going to get it below that. We kind of know you got to be between 2 and 3.5x given what our -- the ability of our business to perform from a cash generation perspective. But in the near term, really to get ASAP below 4x, we think that's an important kind of number to demonstrate that we can quickly bring it down to...

[Gavin Fairweather, analyst]

Okay. And then lastly, maybe for Frank, just on the working capital, it looks like a little bit of outflow this quarter. Is that just timing? Should we think about a reversal in the quarters ahead?

[Frank Di Liso, executive]

I don't think there a reversal we're expecting, Gavin. So we actually get, as you know, paid a lot of upfront for some of the services that we offer. So that will continue. And there's nothing extraordinary that I can remember that's in the working capital this quarter.

[Operator]

Your next question is from Scott Fletcher from CIBC.

[Scott Fletcher, analyst]

Most of my questions have been answered. So I will just ask one. On the -- you sort of spoke to the potential for 10% revenue growth as a result of price increases. Last quarter, you talked about targeting between, I think it was 20% to 25% total growth with half of that organic. So that would sort of imply sort of limited growth from new customers or customer expansion if you're doing 10% from pricing. Is that the case? Or is there sort of -- do you think there's additional upside from winning new customers to that 10% to 12.5% organic growth number?

[Matthew Proud, executive]

Look, we have like large market share across a lot of the markets we're in, where the name of the game is an [indiscernible] new low because it's adding more services to existing customers. That's what we focus on, the cross-sell and the cross-sell under contract has been a big focus of ours. So it's kind of that's the way I would look at it, Scott.

[Scott Fletcher, analyst]

Okay. And then I guess, yes, one question I'll ask is just on the gross margins were materially improved in the quarter. Is that a level we can look at going forward?

[Frank Di Liso, executive]

Yes. I think one of the bigger implications that we mentioned before, Scott, was the divestiture of TM. So they would have carried a lot lower margins. So yes, that's the level you should expect. And given that there was a 1-month contribution of TM in Q1, expected to rise slightly higher.

[Operator]

Your next question is from Robert Young from Canaccord Genuity.

[Robert Young, analyst]

The progress on ARR expansion. Is that all driven by Canada at this point? Or has that expanded into other geographies?

[Matthew Proud, executive]

So we started both in the U.K. and Australia. But most of what you would have seen was the pipeline built the last year in Canada coming online, particularly as Frank mentioned, towards the end of Q4.

[Robert Young, analyst]

And the plan to reduce CapEx that you're highlighting within that $70 million of better free cash, would that have an impact on any of the initiatives to consolidate under Unity and then expand that strategy even if it started in the U.K. and Australia?

[Matthew Proud, executive]

A lot of that work is coming towards an end. So that's why we're having a big reduction in that spend. So that's part of the reduction in CapEx is due to that being concluded towards conclusion.

[Robert Young, analyst]

Okay. And then you added a new Head of Product, a new CRO Head of Sales. And so maybe you can just give us a sense of the changes and how that's going relative to expectations. Then I'll pass line.

[Matthew Proud, executive]

Yes. So we brought in a new CRO and really with the build upon the success we've had in Canada and the selling contracts and taking that -- and build that infrastructure to be able to do that out globally. So we're in the process of kind of rebuilding part of our global teams. A lot of that's already happened.

And so you're seeing us continue to grow ARR even through the first quarter as Aaron came on board. So really excited to have him on board. A veteran when it comes to technology sales, so a real strong add to the team. David Nash, our Chief Product Officer, also joined in the quarter. These are 2 kind of hires you were looking for, for better part of the last fiscal year, there were 2 areas we knew we wanted to do better in.

So also happy to have David on board as he kind of looks to helps us kind of prioritize a bit better our product strategy. Really, as it relates to having more focus on our global legal practice management software business.

[Robert Young, analyst]

Okay. And if I could ask one last question. You talked about some of the businesses in payments information service properties set on the core banking, all of that piece. Could you just expand on what you were -- I might have missed the very beginning of that. What's the point of putting special emphasis around that piece of the business? What are you doing with that going forward? Any other color there, that would be helpful?

[Matthew Proud, executive]

Well, points to give the market just enhanced disclosure around a business that we see a lot of opportunity in. This is a business that is somewhat different to our core legal tech business. Sales cycles are different with banks than they are with the law firms. You're talking a handful of customers, just under 100 versus tens and tens of thousands of them, really focused on small and medium loss. So just reflecting that and having that disclosure, we think is helpful people understand our business more, Rob.

[Robert Young, analyst]

So does that mean you're going to break out segmented revenue, EBITDA? What exactly are you going to expand that?

[Frank Di Liso, executive]

Yes. Those are defined IFRS criteria, Rob. So we didn't meet that threshold in Q1. But as Matt mentioned, putting more emphasis on that and showing the business, then that will be a decision that we make for Q2.

[Operator]

And the next question is from Stephen Boland from Raymond James.

[Stephen Boland, analyst]

Just one question. Obviously, a lot of talk about delevering. Maybe you could just focus a little bit on the convert. That seems to be getting a lot of attention. With this action plans in place, cost reductions, higher revenue, mean are you confident that this additional free cash flow will get you in a position to either pay off all of that 2026 convert before it becomes due or a majority of it? Or do you need another terming out transaction like the one you just did? I'm just -- I think that would be sort of helpful for a lot of people looking at your cash flow over the next couple of years?

[Matthew Proud, executive]

Yes. So there's 2 years left for the remaining convert until it comes due. So we feel very confident our ability to manage that before it comes due. Look, Steve, when we took the opportunity, as I said, in a way that for the company offered -- provided very little additional yield and material to term that out. So we'll continue to look at ways to reduce our indebtedness and including the convert really as soon as possible.

[Stephen Boland, analyst]

Okay. So basically, you feel pretty confident that organically, if it doesn't happen, you can still -- you still have some other options. Is that a fair way to think about it.

[Matthew Proud, executive]

Yes.

[Operator]

No more questions at this time. I will now hand the call back to Mr. Marshall for the closing remarks.

[Ross Marshall]

Thanks, everyone, for joining us this afternoon. We look forward to addressing you in February when we issue our Q2 results. Good night.

[Operator]

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.