Dye & Durham Ltd

TSX:DND

Earnings Call Transcript 2024-Q3

[Operator]

Good morning. My name is Ina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dye & Durham Third Quarter Fiscal 2024 Earnings Call.

I would now like to turn the call over to Mr. Huss Hirji, VP, Investor Relations of Dye & Durham. Mr. Hirji, you may begin your conference.

[Huss Hirji, executive]

Thank you, operator, 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 the 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 include 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, 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 and 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 over the call to Matt for opening remarks.

[Matthew Proud, executive]

Thanks, Huss, and I appreciate the introduction.

Over the last couple of years, Dye & Durham has transformed into one of the largest legal technology software companies in the world. As we continue to build a business to scale, our customers remain at the core of every decision we make as a company. And this is evident given the stickiness of our customer base who truly depend on our products daily.

Our software is primarily targeted at solving the problems faced by small- and medium-sized law firms. In particular, our practice management applications act as a central operating system for law firms, providing them everything they need to run their practice from intake to invoice and truly everything in between.

Our data and insight software seamlessly enables law firms to help their clients assess risk and make informed decisions on any given transaction that a law firm would likely be involved in.

The legal services market is an extremely attractive market in which Dye & Durham is well positioned to capture global market share in this fast-growing and highly fragmented market. This is a market that's forecasted to almost double in the next 6 years.

This afternoon, we reported our third quarter fiscal '24 results. The results continue to demonstrate the strength of our of business and attractiveness of the legal technology market that I've just mentioned.

Our revenue for the 3 months ending March 31, 2024, was $107 million, representing a 16% increase in revenue versus the same period last year when factoring in last summer's divestiture of the TM Group business.

Recently, we've made significant investments into our product offering and go-to-market strategy. This has been targeted at transitioning the business model away from more legacy single-point solution, product-based relationship to a holistic, modern SaaS-based, product-based relationship involving bundling products from different platforms together under a single technology platform. At the core of this is the Unity global platform. The Unity global platform brings together all the tools of small- or medium-sized business law firms require to run their practice, saving our customers time and money and providing real operational cost efficiencies as well as access to the latest technologies in market, including generative AI.

The results of our investments speak for themselves. For the 3 months ending March 31, 2024, ARR was $126 million, which represents an 85% year-over-year growth. Additionally, compared to the previous 3 months ended December 31, 2023, i.e., last quarter, ARR grew by 12% in 1 quarter alone. We targeted to have ARR make up 30% of our revenue by June 30, 2024. That means as of March 31, we achieved that target ahead of plan. And we're still targeting to achieve 50% of our revenue being ARR just over 24 months.

As many of you know, the current quarter we are in is traditionally the strongest quarter for our business, that's Q4, and we have June 30 as year-end. However, we're excited more than usual by the very strong momentum we're seeing in the current quarter. As a result, we believe we're setting up for one of the best quarters on record. The key drivers behind this performance include: first, the large updraft in ARR that we're driving, I just mentioned the trajectory; second, really strong transactional revenue primarily coming from property conveyancing and related due diligence being carried out in our applications. This is, of course, due to recovery in domestic and global real estate markets.

We continue to make investments and drive strong revenue performance while, at the same time, remain disciplined around cost. Rather than embarking on large-scale cost-cutting campaigns, as you would have seen other technology companies undertake in recent days, we believe that consistent attention when it comes to managing cost is a much more healthy and effective way of managing our business. This philosophy is reflected in our adjusted EBITDA performance. We generated adjusted EBITDA of $60 million in the third quarter of fiscal 2024, an increase of 11% compared to the same period last year, taking into consideration the selling of TMG.

Financial flexibility and a strengthened balance sheet remain a key priority for us at Dye & Durham. In this regard, in April, we completed a series of refinancing transactions worth $1.2 billion, which strengthened our balance sheet and improved our capital stack while lowering our expected cash interest payments by approximately $20 million a year next fiscal year on a like-for-like basis.

Prior to the positive impact of refinancing, cash from operations in the quarter was up 26% versus fiscal '23, and adjusted EPS was up 36%. Additionally, this afternoon, we also announced a $185 million substantial issuer bid to retire our remaining 2026 convertible debentures.

As we scale our business, it is important to us to continue to work on deleveraging the business and bring our net debt to approximately 4x adjusted EBITDA or less.

What truly excites me is how we're thinking about the business going forward: positioning the company to outperform based on a superior product offering. Additionally, we're committed to act in the best interest of all the company's stakeholders, and we'll continue to welcome the opportunity to engage in good faith with all stakeholders going forward.

Before I pass it over to Frank, I just want to reiterate how pleased we are with the business performance in Q3 and the results of our current strategy as well as the current trajectory we're seeing in the business in the current quarter and moving forward.

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

[Frank Di Liso, executive]

Thank you, Matt, and good evening, everyone. This evening, we reported our third 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 have reduced our reliance on real estate transactions and increased our annual recurring revenue, which has already achieved our full fiscal year target in Q3, earlier than expected, primarily through growing our practice management solutions. Our annual contracted revenue remains robust driven by both our practice management and our payments infrastructure service lines.

Revenue exposed to real estate transaction globally in Q3 was 43% compared to 50% in the same period of fiscal '23, while revenue exposed to real estate transactions in Canada was only 20% compared to 26% in the same period of last year. Keep in mind that a portion of our real estate exposure in Canada includes refinancing transactions. As a result, our actual exposure to these transactions is lower than 20%.

Annual recurring revenue contracted was 30% as of March 31, 2024, compared to 19% in the same point of 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. These are included in annual contracted revenue, and in the third quarter, this was 53% inclusive of ARR compared to 37% in the prior year.

We reported revenues of $107.3 million during the third quarter, an increase of 16% compared to the same period last year, taking into consideration the sale of TM on August 3, 2023. Revenue grew 3% year-over-year, including the impact of TM in the prior period, mainly as a result of organic initiatives.

Keep in mind that the Q2 and Q3 periods of our fiscal year are typically the weakest from a seasonality perspective, whereas Q4 and Q1, in that order, are typically our strongest periods.

As we reach the midpoint of our fourth quarter, we are seeing positive signals based on market activity, which provided a tailwind for us to finish the year with positive momentum.

We generated adjusted EBITDA of $59.8 million in the third quarter of fiscal '24, an increase of 11% compared to the same period last year, taking into consideration the sale of TM Group, and grew 7% or $3.7 million, including the contribution of TM Group, versus the prior year. Improvement is primarily a result of the growth in organic revenues as well as the impact of our business improvement plan and lower direct costs.

We continue to maintain our strong EBITDA margins coming in at 56% this quarter, which is in line with our target range between 50% and 60%.

Total adjusted operating expenses, which include direct costs, technology costs, G&A and sales and marketing, were $47.6 million for the quarter or 44% of revenue. Adjusted operating expenses for the quarter were lower by approximately 1% from the prior year, including the impact of acquisition operating costs acquired over the last 12 months, which demonstrates the improvements from our business improvement plan.

Net finance costs for the quarter were $30.1 million compared to $40.3 million in the same period of fiscal '23. The improvement was primarily due to the revaluation of the convertible debentures, offset partially by the higher interest expense and loss on discontinuation of hedge accounting on our interest rate swap.

Acquisition, restructuring and other costs for the quarter were $7.1 million. This was a decrease from $15.8 million in the third quarter of fiscal '23 or 55%, and we believe we could deliver additional improvements in this cost item over time. As Matt mentioned earlier, we have taken actions to increase our cash flow performance with a greater emphasis on this measure.

Our business improvement plan generated more than the targeted $70 million in annualized free cash flow improvements on a run rate basis as we exited the third quarter, which includes the impact of the recent refinancing transaction. Our Q3 cash flow from operations was $35 million in the quarter, up 24% compared to the same period last year, mainly as a result of lower acquisition costs and lower amount of taxes paid. On a year-to-date basis, taxes paid reduced by 63% or $15.7 million largely as a result of legal entity consolidations and other tax planning measures.

Basic adjusted net income per share was up 36% to $0.19 in Q3 compared to $0.14 in the same period of last year. As a reminder, basic adjusted net income per share mainly adjusts for noncash items, such as amortization, stock-based compensation, financing gains and losses, which is the closest measure to cash flow per share that we report.

Turning to our balance sheet. Our net debt, excluding the convertible debenture, stood at approximately $948 million as of March 31, 2024, which has been reduced by approximately $102 million since June 30, 2023. Subsequent to the end of the period, we repaid all of our amounts standing under the Ares credit facility with the proceeds from the refinancing transaction. The refinancing transaction in Canadian dollars consisted of approximately $760 million of senior secured notes due 2029, approximately $479 million in a senior secured Term Loan B facility due 2031 and a $105 million revolving credit facility. These refinancing transactions significantly improve our capital structure, eliminated the springing maturity provisions of the Ares facility and results in an estimated $20 million of net interest savings on an annualized basis.

We understand the importance of reducing our leverage, and we have set a clear target to reduce it below 4x 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 built a business of scale that's mission-critical to small- and medium-sized law firms and financial institutions all over the world. Our financial results and the recent actions we've taken demonstrate the consistency of the business and the opportunity that is in front of us.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Robert Young from Canaccord.

[Robert Young, analyst]

A couple of questions. First one, you said that you're setting up for one of the best quarters on record. You didn't give any guidance for the quarter. But I think you said that it's a large updraft in ARR in the quarter and then strong transactional revenue from conveyancing and due diligence. And so I'm curious if you could provide a little bit of additional detail around those components. Should we be expecting fiscal Q4 to be up quarter-over-quarter? Seems likely. Any other context there would be very helpful.

[Matthew Proud, executive]

So yes, I mean I think you've correctly categorized the driver that we reflected. So yes, I mean, as you know, Q4 is traditionally our strongest quarter. We still have approximately half of our business which is transactional today and with overages even beyond that. So yes, we're expecting a very strong quarter that we'll be up versus the current quarter results we just released.

[Robert Young, analyst]

Okay. And then the difference between those two figures, ARR at 30% and contracted revenue of 50%, is the bulk of that overages? If you could talk about the difference between those two figures. Is that where this confidence is coming from? Is it overages on contracted minimums?

[Matthew Proud, executive]

Yes. So we have like really three buckets of revenue, I'll call it. One is traditional, kind of more legacy per transaction revenue, and that's really generally by law firms purchasing per matter or per transaction products on our software. The other bucket is kind of ARR, and that consists of minimum spend contracts as well as visional subscription licenses. And then the third is overages. And that really makes up two things. It's the overages on the minimum spend contracts that you referenced, but it's also we have a lot of contracts -- or all our banking business has contracts with very large financial institutions. And a lot of that, while it's very stable, predictable revenue, it is still revenue under contract with the bank. So those are the three buckets that make it up, to answer your question.

[Robert Young, analyst]

Okay. And then I noticed in the prepared remarks and the release, there wasn't any update on that strategic review of noncore assets. Is there any updated status you can provide on that?

[Matthew Proud, executive]

Not at this time.

[Robert Young, analyst]

Okay. Then last question for me, the substantial issuer bid, can you give us any context around the math or the thought process behind the $900 bid there? And then I'll pass the line.

[Frank Di Liso, executive]

Yes. Rob, this is Frank. The $900 is our best offer that we've made throughout the SIB process. It reflects what we believe is, actually, the premium to the underlying value. More details will follow with our SIB offering that will come out later this week.

[Operator]

And your next question comes from the line of Thanos Moschopoulos from BMO.

[Thanos Moschopoulos, analyst]

You specified your objective of working down your leverage. But just for context, how should we think about how you're going to prioritize that relative to perhaps additional M&A over the next while? I think this was the first quarter in some time that you didn't execute an M&A. But just as we think about the near term, what are your thoughts on M&A versus leveraging?

[Matthew Proud, executive]

Look, I think we've always said, Thanos, it's a balance. We've purposely been focused over the last 12, 24 months on integrating the business, making substantial investments in the things I talked about and really also driving ARR. We believe in the long run having, I said, 50%; but in the long run, also a lot higher amount of kind of very predictable under contract ARR revenue. That said, we're still going to do some tuck-ins from time to time when it makes sense, as we often have the ability to augment our product stack or acquire market share via an acquisition where it makes sense. So again, highly focused and really want to get the leverage down. But if there's an accretive acquisition that makes sense, we have to balance that, too.

[Thanos Moschopoulos, analyst]

Okay. As far as the improved transaction volumes and momentum you're seeing, is that across all your 3 key geographies? Or is it more weighted to one versus the others?

[Matthew Proud, executive]

It's primarily across Canada and Australia, we're seeing it the most. The U.K. market still seems to lag a bit, but yes.

[Thanos Moschopoulos, analyst]

Okay. Working capital was a significant use of cash during the quarter. Can you just expand on that? I mean, is some of that related to restructuring-related payments? Or what's the dynamic? And what should we expect perhaps from a working capital perspective?

[Frank Di Liso, executive]

Yes. Thanos, it's Frank here. What you would have seen in working capital this quarter would have been a use from prepays of about $5 million that was related to our refinancing transaction as we essentially incurred some of those charges in late March. And then on the ARR side, there would have been a use of about $9 million. That reflects a few billings that accumulated in the quarter that we since recovered. So we do expect some reversal of that into Q4.

[Operator]

And your next question comes from the line of Kevin Krishnaratne from Scotiabank.

[Kevin Krishnaratne, analyst]

Just on the organic growth, 4%, wondering if you could dig in there a bit more maybe by geography. I'm just looking at your financials, Canada on a reported basis is up 10%, Australia was down a little bit. I'm just wondering if you can give a bit more color on what you're seeing organic growth-wise across the different geographies. And what are the drivers there?

[Matthew Proud, executive]

Look, I mean, I think we talked about a lot of the drivers there, Kevin, earlier. A lot of the drivers are coming from the legal side of the business. We don't disclose it by geography. But I think we kind of covered that off in our remarks earlier.

[Kevin Krishnaratne, analyst]

Okay. Fair enough. Maybe just a bigger-picture question then with Unity. If you take a typical small law firm in Canada you're serving here, say, look at their revenue per year, how does that compare to a law firm in the U.K. or Australia? And just how do you think about the opportunity for cross-selling with Unity to close that gap?

[Matthew Proud, executive]

It's really the same thing, right? Like if you look at the kind of the two key things we do globally, we do have auxiliary products, but really we're selling legal practice management systems, which really is the central operating system for a law firm as well as their data insight applications provide legal due diligence. The intersection of those 2 products in all markets really is key to our ability to drive extreme stickiness with our clients but also drive that cross-sell. I'd say over and beyond that, adding on auxiliary products, whether it's accounting module, or whatever it may be, that we know law firms require to manage their practice every day, the strategy remains the same in all markets.

[Kevin Krishnaratne, analyst]

And with you rolling out Unity into, I think, it was in the U.K., are you seeing like a lift in ARPUs in the law firms? Are you actually seeing that materialize? Do we see that benefit into the next quarter?

[Matthew Proud, executive]

So we only started early this year selling contracts in the U.K., and it's a great trajectory so far. We're starting to see some momentum in customers signing up contracts and cross-sell as well as we kind of go to market with both the practice management offering as well as all our due diligence capabilities under one platform. So that cross-sell has been very real and very good to see.

[Operator]

And your next question comes from the line of Stephen Boland from Raymond James.

[Stephen Boland, analyst]

Okay. I guess I'll be the one to ask the question, Matt. What can you talk about with the Engine Capital? I know there was probably dialogue earlier. Now it seems to have gone into a more formal press release type of relationship. Is there an ongoing dialogue with them? Or are you just going to be waiting for the meeting to occur?

[Matthew Proud, executive]

Yes. Look, I mean, happy to take that question, and thanks for putting it on the table. Look, we're willing to talk to all shareholders and have a constructive dialogue. It's always good to listen and hear what people have to say. And you often hear good feedback from our shareholders, including Engine. We've got some very constructive conversations with them on how they see the business, and we'll continue that, again, with Engine and all shareholders. That said, we're continuing to run the business. We're very happy with the performance. The trajectory, we think, is extremely strong. So that's our main focus. And we'll continue to engage again with all shareholders.

[Stephen Boland, analyst]

Okay. There was a slide in the deck that was somewhat new just on the product side. And you talked about some of the fastest-growing segments. And I guess, practice management, I understand, but analytics is another one that you're offering. Can you just explain what legal firms are doing, what analytics they're using?

[Matthew Proud, executive]

Yes. What our customers do, I mean, it's analyzing risk, right? If you're doing legal due diligence in a law firm on behalf of your clients, we provide the software that enables them to assess risk on really any given corporate transaction or property transaction, really going to the client and say, "Hey, this is the risk associated with the transaction," and provide insight into that risk. And so again, we're sitting here looking at like key growth areas, practice management, analytics. These are core competencies at Dye & Durham. So as this market globally looks to expand from almost double from kind of USD 26 billion to just under USD 50 billion by 2030, we're very well positioned, particularly given our existing market share and where we're focused on growth and capturing that market uplift.

[Stephen Boland, analyst]

And then the last piece there was the legal research. Maybe just if you could explain to me what that is. And is this something that you're going to need in the next couple of years to be offering?

[Matthew Proud, executive]

No. We don't see ourselves, I mean, today, getting into legal research. It's a market that's fairly well dominated by the likes of Thomson Reuters, LexisNexis, probably the 2 largest legal tech companies in the world. They service it very well and do a very good job of, again, servicing the customers in that market. So we don't see ourselves trying to break into that market. It's not a focus of ours.

[Stephen Boland, analyst]

Okay. And I'll sneak one more in. Just I know your focus has been on the balance sheet. But certainly, I know you've got a large pipeline of deals or always looking at or evaluating. Is it fair to say that maybe you saw a company or two that you like, but you just thought the timing isn't right? Or has it just been nothing out there that you've seen that really fit your appetite?

[Matthew Proud, executive]

So it's good question. I can kind of answered it earlier like we'll transact if we see something. But again, we're really focused on getting that leverage down. Look, we believe leverage remains a drag on the valuation of the business. We have some slides in our deck. We looked at kind of, since IPO, how it has performed. And while we're doing good, we think we'd do a lot better. We think leverage remains one of the main drags. So a key priority for us is get that leverage down. We have a near-term goal of below 4x. But obviously, longer term, you know we're kind of going to be down closer to at least 3, kind of operating in between that 2.5 to 3.5 for the long run. So again, can't take our eyes off the ball. But again, you got to balance it.

[Operator]

And your next question comes from the line of Scott Fletcher from CIBC.

[Scott Fletcher, analyst]

Just a couple of follow-ups from me. On an earlier question, so when you announced the new debt package, you called out a run rate adjusted EBITDA number of $278 million. With Q4 being the seasonally strong quarter, should we be expecting adjusted EBITDA above the sort of $70 million quarterly run rate implied by that $278 million number?

[Matthew Proud, executive]

So the $278 million, I mean, we called it further adjusted EBITDA and really a lender metric. It's the kind of forward-looking outstanding synergies left in the business. And we kind of have, I think, $27 million remaining from our December 31 LTM versus the remaining synergies, so there's a $27 million difference.

We said by the end of December calendar year '24, we'd capture most of those synergies. And we, from an execution perspective, had a lot of them kind of actioned on by the end of this quarter, early Q1. So feeling really good, we're making a really good trajectory on kind of taking those costs out of the business. So that's what that kind of relates to.

As of Q4, I mean look, the trends in our business, the drivers, what we're seeing both from a macro perspective and what we're driving internally is really, really promising. And so if you look at it, historically, Q4 has been a very strong quarter. And we think this one will be set to be one of the strongest so far.

[Frank Di Liso, executive]

Yes, one of the factors, Scott, in Q4 was there is an increase in the amount of business days relative to the previous year. So that's just the timing of the Easter holiday, just as another factor.

[Scott Fletcher, analyst]

Okay. And then just on the deleveraging note, obviously, you're freeing up some excess free cash with the new debt. Does the new package give you flexibility to make regular repayments on either of the new facilities?

[Matthew Proud, executive]

As you would have seen in the disclosure, it's obviously a lot easier to prepay the loan versus the bond. The bond has call protection on it that's quite substantial. But it's pretty straightforward to repay the loan, should you wish to.

[Operator]

And your next question comes from the line of Robert Young from Canaccord.

[Robert Young, analyst]

Just a follow-up, I'm trying to understand the positive comments on Australia and the trends there. But in the quarter, the revenue was down. I think someone asked the question, but I didn't catch the answer. I just wonder if you could touch on that, just trying to understand that difference.

[Matthew Proud, executive]

Yes. No, I was more talking about and probably pivoted more to drivers. A lot of that is due to FX as well.

[Robert Young, analyst]

All of it? Or maybe we can break down the pieces there.

[Frank Di Liso, executive]

Rob, yes, the FX had a portion of the change year-over-year. But yes, we can't disclose the pieces of specifically what's FX versus the business. But we just want to mention that FX was one of the major drivers of the decline.

[Operator]

There are no further questions at this time. I will now hand the call back to Mr. Huss Hirji for closing remarks.

[Huss Hirji, executive]

Great. Thanks all for attending, and we look forward to connecting with you during our Q4 full year results to be held in September. Until then, have a great day and speak to you soon.

[Operator]

Thank you. That concludes our conference for today. Thank you for participating. You may all disconnect.