UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2017

OR

Commission File Number 1-37728

 

Donnelley Financial Solutions, Inc.

(Exact name of registrant as specified in its charter)

 

 

(844) 866-4337

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐    No  ☒

As of October 27, 2017, 33.7 million shares of common stock were outstanding.  

 

 

 

 

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DONNELLEY FINANCIAL SOLUTIONS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED September 30, 2017

 

TABLE OF CONTENTS

 

 

 

 

 

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Donnelley Financial Solutions, Inc. and Subsidiaries (“Donnelley Financial”)

Condensed Consolidated and Combined Statements of Operations

For the Three and Nine Months Ended September 30, 2017 and 2016

(in millions, except per share data)

(UNAUDITED)

 

 

 

See Notes to Unaudited Condensed Consolidated and Combined Financial Statements

 

 

 

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Donnelley Financial Solutions, Inc. and Subsidiaries (“Donnelley Financial”)

Condensed Consolidated and Combined Statements of Comprehensive Income

For the Three and Nine Months Ended September 30, 2017 and 2016

(in millions)

(UNAUDITED)

 

 

See Notes to Unaudited Condensed Consolidated and Combined Financial Statements

 

 

 

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Donnelley Financial Solutions, Inc. and Subsidiaries (“Donnelley Financial”)

Condensed Consolidated Balance Sheets

As of September 30, 2017 and December 31, 2016

(in millions, except per share data)

(UNAUDITED)

 

 

 

See Notes to Unaudited Condensed Consolidated and Combined Financial Statements

 

 

 

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‘Donnelley Financial Solutions, Inc. and Subsidiaries (“Donnelley Financial”)

Condensed Consolidated and Combined Statements of Cash Flows

For the Nine Months Ended September 30, 2017 and 2016

(in millions)

(UNAUDITED)

 

 

See Notes to Unaudited Condensed Consolidated and Combined Financial Statements

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Note 1. Overview and Basis of Presentation

Description of Business

Donnelley Financial Solutions, Inc. (the “Company” or “Donnelley Financial” ) is a financial communications services company that supports global capital markets compliance and transaction needs for its corporate clients and their advisors (such as law firms and investment bankers) and global investment markets compliance and analytics needs for mutual fund companies, variable annuity providers and broker/dealers. With proprietary technology such as data storage and workflow collaboration tools, deep subject matter expertise and a global footprint, Donnelley Financial produces, manages, stores, distributes, and translates documents and electronic communications in order to deliver timely financial communications to investors and documents in a manner that complies with regulatory commissions.

Donnelley Financial’s Registration Statement on Form 10, as amended, was declared effective by the U.S. Securities and Exchange Commission (the “SEC”) on September 20, 2016. On October 1, 2016, Donnelley Financial became an independent publicly traded company through the distribution by R.R. Donnelley & Sons Company (“RRD”) of approximately 26.2 million shares, or 80.75%, of Donnelley Financial common stock to RRD shareholders (the “Separation”). Holders of RRD common stock received one share of Donnelley Financial common stock for every eight shares of RRD common stock held on September 23, 2016. As part of the Separation, RRD retained approximately 6.2 million shares of Donnelley Financial common stock, or a 19.25% interest in Donnelley Financial. Donnelley Financial’s common stock began regular-way trading under the ticker symbol “DFIN” on the New York Stock Exchange on October 3, 2016.  On October 1, 2016, RRD also completed the previously announced separation of LSC Communications, Inc. (“LSC”), its publishing and retail-centric print services and office products business. On March 28, 2017, RRD completed the sale of 6.2 million shares of LSC common stock (RRD’s remaining ownership stake in LSC) in an underwritten public offering. As a result, beginning in the quarter ended June 30, 2017, LSC is no longer an affiliate of the Company.

On September 14, 2016, the Company and LSC entered into a Separation and Distribution Agreement with RRD to effect the distribution of the Company’s and LSC’s common stock to RRD’s common stockholders (the “Separation and Distribution Agreement”). This agreement governs the Company’s relationship with RRD and LSC with respect to pre-Separation matters and provides for the allocation of employee benefit, litigation and other liabilities and obligations attributable to periods prior to the Separation. The Separation and Distribution Agreement also includes an agreement that the Company, RRD and LSC will provide each other with appropriate indemnities with respect to liabilities arising out of the businesses being distributed and retained by RRD in the Separation. The Separation and Distribution Agreement also addresses employee compensation and benefit matters.

In connection with the Separation, the Company entered into transition services agreements separately with RRD and LSC, under which, in exchange for the fees specified in the arrangements, RRD and LSC agree to provide certain services to the Company and the Company agrees to provide certain services to RRD, respectively, for up to 24 months following the Separation. These services include, but are not limited to, information technology, accounts receivable, accounts payable, payroll and other financial and administrative services and functions. These agreements facilitate the separation by allowing the Company to operate independently prior to establishing stand-alone back office systems across its organization.  

At the time of the Separation, the Company entered into a number of commercial and other arrangements with RRD and its subsidiaries. These include, among other things, arrangements for the provision of services, including global outsourcing and logistics services, printing and binding, digital printing, composition, premedia and access to technology. The Company also entered into a number of commercial and other arrangements with LSC and its subsidiaries, pursuant to which LSC will print and bind products for the Company. The terms of the arrangements with RRD and LSC do not exceed 24 months. Subsequent to the Separation, RRD and LSC are clients of the Company and expect to utilize financial communication software and services that the Company makes available to all of its clients.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

On March 24, 2017, pursuant to the Stockholder and Registration Rights Agreement, dated as of September 30, 2016, by and between the Company and RRD, the Company filed a Registration Statement on Form S-1 to register the offering and sale of shares of the Company’s common stock retained by RRD. The Registration Statement on Form S-1, as amended, was declared effective by the SEC on June 13, 2017. On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. Upon the consummation of the offering, RRD retained approximately 0.1 million shares of the Company’s common stock which were subsequently sold by RRD on August 1, 2017. In conjunction with the underwritten public offering, the underwriters exercised their option to purchase approximately 0.9 million of the Company’s shares (the “Option Shares”). The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. The proceeds were used to reduce outstanding debt under the Revolving Facility (as defined in Note 11, Debt). Beginning in the quarter ended September 30, 2017, RRD no longer qualified as a related party, therefore amounts disclosed related to RRD are presented through June 30, 2017 only.  

Basis of Presentation

The accompanying unaudited condensed consolidated and combined financial statements reflect the consolidated financial position and consolidated results of operations of the Company as an independent, publicly traded company for the periods after the Separation and the combined financial position and combined results of operations for the periods prior to the Separation. Prior to the Separation, the combined financial statements were prepared on a stand-alone basis and were derived from RRD’s consolidated financial statements and accounting records.

The unaudited condensed consolidated and combined financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The financial data presented herein should be read in conjunction with the audited consolidated and combined financial statements and accompanying notes included in the Company’s latest Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC on February 28, 2017. In the opinion of management, the financial data presented includes all adjustments necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented. Results of interim periods should not be considered indicative of the results for the full year. These unaudited condensed consolidated and combined interim financial statements include estimates and assumptions of management that affect the amounts reported in the unaudited condensed consolidated and combined financial statements. Actual results could differ from these estimates.

For periods prior to the Separation, the unaudited condensed consolidated and combined financial statements include the allocation of certain assets and liabilities that were historically held at the RRD corporate level but which were specifically identifiable or attributable to the Company.  Cash and cash equivalents held by RRD were not allocated to Donnelley Financial unless they were held in a legal entity that was transferred to Donnelley Financial. All intercompany transactions and accounts within Donnelley Financial have been eliminated. All intracompany transactions between RRD and Donnelley Financial are considered to be effectively settled in the unaudited condensed consolidated and combined financial statements at the time the transaction is recorded. The total net effect of the settlement of these intracompany transactions is reflected in the unaudited condensed consolidated and combined statements of cash flows as a financing activity and in the unaudited condensed consolidated and combined balance sheets as net parent company investment. Net parent company investment is primarily impacted by contributions from RRD which are the result of treasury activities and net funding provided by or distributed to RRD.  

Prior to the Separation, the unaudited condensed consolidated and combined financial statements include certain expenses of RRD which were allocated to Donnelley Financial for certain functions, including general corporate expenses related to information technology, finance, legal, human resources, internal audit, treasury, tax, investor relations and executive oversight.  These expenses were allocated to the Company on the basis of direct usage, when available, with the remainder allocated on the pro rata basis of revenue, employee headcount, or other measures. We consider the expense methodology and results to be reasonable for all periods presented.  However these allocations may not be indicative of the actual expenses that would have been incurred as an independent public company or the costs that may be incurred in the future.

For periods prior to the Separation, the income tax amounts in the unaudited condensed consolidated and combined financial statements were calculated based on a separate income tax return methodology and presented as if the Company’s operations were separate taxpayers in the respective jurisdictions.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

RRD maintained various benefit and share-based compensation plans at a corporate level.  Donnelley Financial employees participated in those programs and a portion of the cost of those plans is included in Donnelley Financial’s condensed consolidated and combined financial statements for periods prior to the Separation.  On October 1, 2016, Donnelley Financial recorded net pension plan liabilities of $68.3 million (consisting of a total benefit plan liability of $317.0 million, net of plan assets having fair market value of $248.7 million), as a result of the transfer of certain pension plan liabilities and assets from RRD to the Company upon the legal split of those plans. The pension plan asset allocation from RRD was finalized on June 30, 2017, which resulted in a $0.7 million decrease to the fair value of plan assets transferred to the Company from RRD. The Company also recorded a net other postretirement benefit liability of $1.5 million, as a result of the transfer of an other postretirement benefit plan from RRD to the Company. Refer to Note 6, Retirement Plans, for further details regarding the Company’s pension and other postretirement benefit plans.

Donnelley Financial generates a portion of net revenue from sales to RRD’s subsidiaries. Included in the unaudited condensed combined financial statements are net revenues from sales to RRD and affiliates of $1.1 million and $3.6 million for the three months and nine months ended September 30, 2016, respectively. Donnelley Financial utilizes RRD for freight and logistics, production of certain printed products and outsourced business services functions. Included in the unaudited condensed combined financial statements are cost of sales to RRD and affiliates of $20.2 million and $78.0 million for the three and nine months ended September 30, 2016, respectively.  Intercompany receivables and payables with RRD are reflected within net parent company investment in the accompanying unaudited condensed combined financial statements for periods prior to the Separation. See Note 13, Related Parties, for a further description of related party transactions.

 

 

Note 2. Inventories

The components of the Company’s inventories, net of excess and obsolescence reserves for raw materials and finished goods, at September 30, 2017 and December 31, 2016 were as follows:  

 

 

 

Note 3. Property, Plant and Equipment

The components of the Company’s property, plant and equipment at September 30, 2017 and December 31, 2016 were as follows:

   

 

Depreciation expense was $1.9 million and $1.4 million for the three months ended September 30, 2017 and 2016, respectively, and $5.0 million and $6.1 million for the nine months ended September 30, 2017 and 2016, respectively.  

 

 

Note 4. Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2017 were as follows:

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

 

The components of other intangible assets at September 30, 2017 and December 31, 2016 were as follows:

 

 

Amortization expense for other intangible assets was $3.6 million and $3.6 million for the three months ended September 30, 2017 and 2016, respectively, and $10.7 million and $10.8 million for the nine months ended September 30, 2017 and 2016, respectively.

The following table outlines the estimated annual amortization expense related to other intangible assets as of September 30, 2017:

 

 

Note 5. Restructuring, Impairment and Other Charges

Restructuring, Impairment and Other Charges recognized in Results of Operations

For the three months ended September 30, 2017 and 2016, the Company recorded the following net restructuring, impairment and other charges:

 

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

For the nine months ended September 30, 2017 and 2016, the Company recorded the following net restructuring, impairment and other charges:

 

 

Restructuring and Impairment Charges

For the three and nine months ended September 30, 2017, the Company recorded net restructuring charges of $0.4 million and $5.2 million, respectively, for employee termination costs for 169 employees, substantially all of whom were terminated as of September 30, 2017. These charges primarily related to the reorganization of certain operations and certain administrative functions. Additionally, the Company recognized a net reversal of $1.0 million of other restructuring charges during the three months ended September 30, 2017 primarily due to the reversal of previously recognized lease termination costs associated with a facility that the Company began using during the third quarter of 2017. The Company incurred net lease termination and other restructuring charges of $0.9 million for the nine months ended September 30, 2017.  For the nine months ended September 30, 2017, the Company also recorded $0.2 million of net impairment charges primarily related to leasehold improvements associated with facility closures.  The nine months ended September 30, 2017 includes $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.

For the three and nine months ended September 30, 2016, the Company recorded net restructuring charges of $1.3 million and $2.3 million, respectively, for employee termination costs for 22 employees. These charges primarily related to the reorganization of certain administrative functions. Additionally, the Company incurred lease termination and other restructuring charges of $0.4 million and $1.2 million, respectively, for the three and nine months ended September 30, 2016. The nine months ended September 30, 2016, includes $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.

 

Restructuring Reserve

The restructuring reserve as of December 31, 2016 and September 30, 2017, and changes during the nine months ended September 30, 2017, were as follows:

 

 

The current portion of restructuring reserves of $3.2 million at September 30, 2017 was included in accrued liabilities, while the long-term portion of $1.8 million, primarily related to lease termination costs, was included in other noncurrent liabilities at September 30, 2017.

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

The Company anticipates that payments associated with the employee terminations reflected in the above table will be substantially completed by March 31, 2018.

The restructuring liabilities classified as “lease terminations and other” consisted of lease terminations, other facility closing costs and contract termination costs. Payments on certain of the lease obligations are scheduled to continue until 2026. Market conditions and the Company’s ability to sublease these properties could affect the ultimate charges related to the lease obligations. Any potential recoveries or additional charges could affect amounts reported in the Company’s financial statements.

 

Note 6. Retirement Plans

Donnelley Financial’s Participation in RRD’s Pension and Postretirement Benefit Plans

RRD provided pension and other postretirement healthcare benefits to certain current and former employees of Donnelley Financial.  Prior to the Separation, RRD was responsible for the net benefit plan obligations associated with these plans, and as such, these liabilities are not reflected in Donnelley Financial’s unaudited condensed consolidated and combined balance sheets.

Donnelley Financial’s unaudited condensed consolidated and combined statements of operations include expense allocations for these benefits. These allocations were funded through intercompany transactions with RRD which are reflected within net parent company investment in Donnelley Financial. Total RRD pension and postretirement benefit plan net income allocated to Donnelley Financial, related to pension cost and postretirement benefits, was $1.3 million and $4.2 million in the three and nine months ended September 30, 2016, respectively. Included in these amounts is an allocation for other postretirement benefit plans for $0.3 million and $1.0 million in the three and nine months ended September 30, 2016, respectively.  These allocations are reflected in the Company’s cost of sales and selling, general and administrative expenses.  

Donnelley Financial’s Pension and Postretirement Benefit Plans

On October 1, 2016, Donnelley Financial recorded net pension plan liabilities of $68.3 million (consisting of a total benefit plan liability of $317.0 million, net of plan assets having fair market value of $248.7 million), as a result of the transfer of certain pension plan liabilities and assets from RRD to the Company upon the legal split of those plans. The pension plan asset allocation from RRD was finalized on June 30, 2017, which resulted in a $0.7 million decrease to the fair value of plan assets transferred to the Company from RRD. The Company also recorded a net other postretirement benefit liability of $1.5 million, as a result of the transfer of an other postretirement benefit plan from RRD to the Company.

The components of the estimated net pension plan income for Donnelley Financial’s pension plans for the three and nine months ended September 30, 2017 and 2016 were as follows:  

 

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Note 7. Equity

The Company’s equity as of December 31, 2016 and September 30, 2017, and changes during the nine months ended September 30, 2017, were as follows:

 

 

Separation-related adjustments primarily relate to adjustments arising from the finalization of tax returns for periods prior to the Separation as well as settlement of balances due to or from RRD for activity prior to the Separation.

On June 21, 2017, the Company issued stock in conjunction with the underwritten public offering of the sale of the Company’s shares retained by RRD. The underwriters exercised their option to purchase approximately 0.9 million Option Shares. The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. Refer to Note 1, Overview and Basis of Presentation, for further details.

The Company’s equity as of December 31, 2015 and September 30, 2016, and changes during the nine months ended September 30, 2016, were as follows:

 

 

 

Note 8. Earnings per Share

Basic earnings per share is calculated by dividing net earnings by the weighted average number of common shares outstanding for the period. In computing diluted earnings per share, basic earnings per share is adjusted for the assumed issuance of all potentially dilutive share-based awards, including restricted stock units and restricted stock.

On October 1, 2016, RRD distributed approximately 26.2 million shares of Donnelley Financial common stock to RRD shareholders in connection with the spin-off of Donnelley Financial, with RRD retaining approximately 6.2 million shares of Donnelley Financial common stock. Holders of RRD common stock received one share of Donnelley Financial for every eight shares of RRD common stock held on September 23, 2016. Basic and diluted earnings per common share and the average number of common shares outstanding were retrospectively restated for the number of Donnelley Financial shares outstanding immediately following this transaction. For periods prior to the Separation, basic and diluted earnings per share were calculated using the number of shares distributed and retained by RRD, totaling 32.4 million. The same number of shares was used to calculate basic and diluted earnings per share since there were no Donnelley Financial equity awards outstanding prior to the spin-off.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. Upon consummation of the offering, RRD retained approximately 0.1 million shares of the Company’s common stock which were subsequently sold by RRD on August 1, 2017. Refer to Note 1, Overview and Basis of Presentation, for further details.

As a result of the Company adopting Accounting Standards Update 2016-09 “Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” beginning in the first quarter of 2017, excess tax benefits and tax deficiencies are excluded from the calculation of assumed proceeds when using the treasury stock method in calculating diluted earnings per share.

The reconciliation of the numerator and denominator of the basic and diluted earnings per share calculation and the anti-dilutive share-based awards for the three and nine months ended September 30, 2017 and 2016 were as follows:

 

 

 

Note 9. Comprehensive Income

The components of other comprehensive income and income tax expense allocated to each component for the three and nine months ended September 30, 2017 and 2016 were as follows:

 

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Accumulated other comprehensive loss by component as of December 31, 2016 and September 30, 2017 were as follows:

 

 

 

Accumulated other comprehensive loss by component as of December 31, 2015 and September 30, 2016 as follows:

 

 

 

Reclassifications from accumulated other comprehensive loss for the three and nine months ended September 30, 2017 and 2016 were as follows:  

 

  

 

 

 

Note 10. Segment Information

The Company’s segments are summarized below:

United States

The U.S. segment serves capital market and investment market clients in the U.S. by delivering products and services to help create, manage, and deliver, accurate and timely financial communications to investors and regulators. The Company also provides virtual data rooms to facilitate the deal management requirements of capital markets and mergers and acquisitions transactions, and provides data and analytics services that help professionals uncover intelligence from disclosures contained within public filings made with the SEC. The U.S. segment also includes language solutions capabilities, through which the Company can translate documents and create content in up to 190 different languages for its clients, and commercial print.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

International

The International segment includes the Company’s operations in Asia, Europe, Canada and Latin America. The international business is primarily focused on working with international capital markets clients on capital markets offerings and regulatory compliance related activities into or within the United States. In addition, the international segment provides language translation services and shareholder communication services to investment market clients.

Corporate

Corporate consists of unallocated selling, general and administrative activities and associated expenses including, in part, executive, legal, finance, communications and certain facility costs.  In addition, certain costs and earnings of employee benefit plans, such as pension and other postretirement benefit plan expense (income) and allocated costs for share-based compensation, are included in Corporate and not allocated to the operating segments.

Information by Segment

The Company has disclosed income (loss) from operations as the primary measure of segment earnings (loss). This is the measure of profitability used by the Company’s chief operating decision-maker and is most consistent with the presentation of profitability reported within the consolidated and combined financial statements.

 

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

 

 

 

Note 11. Debt

On September 30, 2016, in connection with the Separation, the Company entered into a Credit Agreement (the “Credit Agreement”) by and among the Company, the lenders party thereto from time to time and JPMorgan Chase Bank, N.A., as administrative agent. The Credit Agreement provides for (i) a new senior secured term loan B facility in an aggregate principal amount of $350.0 million (the “Term Loan Credit Facility”) and (ii) a new first lien senior secured revolving credit facility in an aggregate principal amount of $300.0 million (the “Revolving Facility”, and, together with the Term Loan Credit Facility, the “Credit Facilities”). The Credit Agreement contains a number of covenants, including a minimum Interest Coverage Ratio and a maximum Leverage Ratio, as defined in and calculated pursuant to the Credit Agreement, that, in part, restrict the Company’s ability to incur additional indebtedness, create liens, engage in mergers and consolidations, make restricted payments and dispose of certain assets. The Credit Agreement generally allows annual dividend payments of up to $15.0 million in the aggregate. As of September 30, 2017, there were no outstanding borrowings under the Revolving Facility.

Borrowings under the Term Loan Credit Facility were used to provide $340.2 million of cash to RRD, pursuant to the Separation Agreement, as of September 30, 2016. The remainder of the net proceeds was used for general corporate purposes.

Pursuant to the Separation and Distribution Agreement, the Company received a cash payment of $68.0 million from RRD on April 3, 2017. The proceeds were used to reduce outstanding debt under the Term Loan Credit Facility.

On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. Upon the consummation of the offering, RRD retained approximately 0.1 million shares of the Company’s common stock of the offering which were subsequently sold by RRD on August 1, 2017. In conjunction with the underwritten public offering, the underwriters exercised their option to purchase approximately 0.9 million Option Shares. The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. The proceeds were used to reduce outstanding debt under the Revolving Facility.

On October 2, 2017, the Company repriced the Term Loan Credit Facility. As a result, the interest rate was reduced by 100 basis points to LIBOR plus 3.0% and the LIBOR floor was reduced by 25 basis points to .75%. Additionally, under the amended Credit Agreement, principal payments are due on a quarterly basis. Other terms, including the outstanding principal, maturity date, and debt covenants such as the minimum Interest Coverage Ratio and the maximum Leverage Ratio are consistent with the original Credit Agreement. 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

On September 30, 2016, also in connection with the Separation, the Company issued $300.0 million of 8.25% senior unsecured notes due October 15, 2024 (the “Notes”). Interest on the Notes is payable semi-annually on April 15 and October 15, commencing on April 15, 2017. The issuance of the Notes was part of a debt exchange that resulted in the settlement of certain of RRD's bonds. The Notes were issued pursuant to an indenture where certain wholly-owned domestic subsidiaries of the Company guarantee the Notes (the “Guarantors”).  The Notes are jointly and severally guaranteed, on an unsecured basis, by the Guarantors, which are comprised of each of the Company’s existing and future direct and indirect wholly-owned U.S. subsidiaries that guarantee the Company’s obligations under the Credit Facilities. The Notes are not guaranteed by the Company’s foreign subsidiaries or unrestricted subsidiaries. The Notes and the related guarantees will be the Company and the Guarantors’, respective, senior unsecured obligations and will rank equally in right of payment to all present and future senior debt, including the obligations under the Company’s Credit Facilities, senior in right of payment to all present and future subordinated debt, and effectively subordinated in right of payment to any of the Company and the Guarantors’ secured debt, to the extent of the value of the assets securing such debt. The indenture governing the Notes contains certain covenants applicable to the Company and its restricted subsidiaries, including limitations on: (1) liens; (2) indebtedness; (3) mergers, consolidations and acquisitions; (4) sales, transfers and other dispositions of assets; (5) loans and other investments; (6) dividends and other distributions, stock repurchases and redemptions and other restricted payments; (7) restrictions affecting subsidiaries; (8) transactions with affiliates; and (9) designations of unrestricted subsidiaries. Each of these covenants is subject to important exceptions and qualifications.

In connection with the offering of the Notes, the Company entered into a registration rights agreement, dated as of September 30, 2016 (the “Registration Rights Agreement”), pursuant to which the Company agreed to file a registration statement with the SEC with respect to an offer to exchange the Notes for registered notes. In certain circumstances, the Company may be required to file a shelf registration statement with the SEC registering the resale of the Notes by the holders thereof, in lieu of an exchange offer to such holders. On March 10, 2017, the Company filed a Registration Statement on Form S-4 (as amended, the “Exchange Offer Registration Statement”) to offer to exchange the Notes for registered notes which have terms identical in all material respects to the Notes except that the registered notes are not subject to transfer restrictions or registration rights. The Exchange Offer Registration Statement was declared effective by the SEC on March 22, 2017. An exchange offer for the Notes was launched on March 22, 2017 and settled on April 25, 2017, resulting in the exchange of $299.9 million aggregate principal amount of outstanding Notes for registered notes.

The Company’s debt as of September 30, 2017 and December 31, 2016 consisted of the following:

 

 

The fair value of the senior notes, which was determined using the market approach based upon interest rates available to the Company for borrowings with similar terms and maturities, were determined to be Level 2 under the fair value hierarchy. The fair value of the Company’s senior notes was $322.2 million and $307.1 million at September 30, 2017 and December 31, 2016, respectively.

The weighted average interest rate on borrowings under the Revolving Facility was 4.4% at September 30, 2017.

 

Note 12. Commitments and Contingencies

Litigation

From time to time, the Company’s customers and others file voluntary petitions for reorganization under United States bankruptcy laws. In such cases, certain pre-petition payments received by the Company from these parties could be considered preference items and subject to return. In addition, the Company may be party to certain litigation arising in the ordinary course of business. Management believes that the final resolution of these preference items and litigation will not have a material effect on the Company’s consolidated and combined results of operations, financial position or cash flows.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

 

 

Note 13.  Related Parties

On March 28, 2017, RRD completed the sale of 6.2 million shares of LSC common stock (RRD’s remaining ownership stake in LSC) in an underwritten public offering. As a result, beginning in the quarter ended June 30, 2017, LSC is no longer an affiliate of the Company.

On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock.  RRD retained approximately 0.1 million shares of the Company’s common stock which RRD sold on August 1, 2017. Beginning in the quarter ended September 30, 2017, RRD no longer qualified as a related party and the amounts disclosed related to RRD are presented through June 30, 2017 only.

Transition Services Agreements

In connection with the Separation, the Company entered into transition services agreements separately with RRD and LSC, under which, in exchange for the fees specified in the arrangements, RRD and LSC agree to provide certain services to the Company and the Company agrees to provide certain services to RRD, respectively, for up to 24 months following the Separation. These services include, but are not limited to, information technology, accounts receivable, accounts payable, payroll and other financial and administrative services and functions. These agreements facilitate the separation by allowing the Company to operate independently prior to establishing stand-alone back office systems across its organization.  

Commercial Arrangements

The Company entered into a number of commercial and other arrangements with RRD and its subsidiaries. These include, among other things, arrangements for the provision of services, including global outsourcing and logistics services, printing and binding, digital printing, composition and access to technology. The Company also entered into a number of commercial and other arrangements with LSC and its subsidiaries, pursuant to which LSC will print and bind products for the Company. The terms of the arrangements with RRD and LSC do not exceed 24 months. Subsequent to the Separation, RRD and LSC are clients of the Company and expect to utilize financial communication software and services that the Company provides to all of its clients.

Stockholder and Registration Rights Agreement

The Company and RRD entered into a Stockholder and Registration Rights Agreement with respect to the Company’s common stock retained by RRD pursuant to which the Company agrees that, upon the request of RRD, the Company will use its reasonable best efforts to effect the registration under applicable federal and state securities laws of the shares of the Company’s common stock retained by RRD after the Separation. In addition, RRD granted the Company a proxy to vote the shares of the Company’s common stock that RRD retained immediately after the Separation in proportion to the votes cast by the Company’s other stockholders. This proxy, however, will be automatically revoked as to a particular share upon any sale or transfer of such share from RRD to a person other than RRD, and neither the voting agreement nor the proxy will limit or prohibit any such sale or transfer.

On March 24, 2017, pursuant to the Stockholder and Registration Rights Agreement, the Company filed a Registration Statement on Form S-1 to register the offering and sale of the Company’s common stock retained by RRD. The Registration Statement on Form S-1, as amended, was declared effective by the SEC on June 13, 2017. On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. Upon consummation of the offering, RRD retained approximately 0.1 million shares of the Company’s common stock which were subsequently sold by RRD on August 1, 2017.

Sublease Agreement

In connection with the Separation, the Company assumed an operating lease through 2024 for the Company’s headquarters.  There is a related non-cancelable sublease rental to RRD for the same period.  The Company remains secondarily liable under this lease in the event that the sub-lessee defaults under the sublease terms. The Company does not believe that material payments will be required as a result of the secondary liability provisions of the primary lease agreement.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Related Party Receivables/Payables

Pursuant to the Separation and Distribution Agreement, the Company received a cash payment of $68.0 million from RRD on April 3, 2017. The proceeds were used to reduce outstanding debt under the Term Loan Credit Facility. The Company has other amounts due to or from RRD in the normal course of business. The Company had $96.0 million of receivables from RRD and $27.1 million of payables to RRD included in the condensed consolidated balance sheet at December 31, 2016.   

Allocations from RRD

Prior to the Separation RRD provided Donnelley Financial with certain services, which include, but are not limited to information technology, finance, legal, human resources, internal audit, treasury, tax, investor relations and executive oversight. The financial information in these consolidated and combined financial statements does not necessarily include all the expenses that would have been incurred had Donnelley Financial been a separate, standalone entity for all periods presented. Prior to the Separation RRD charged Donnelley Financial for these services based on direct usage when possible. When specific identification was not practicable, the pro rata basis of revenue or employee headcount, or some other measure was used. These allocations were reflected as follows in the unaudited condensed consolidated and combined financial statements:

 

 

The Company considers the expense methodology and results to be reasonable for all periods presented.  However, these allocations may not be indicative of the actual expenses that the Company would have incurred as an independent public company or the costs it may incur in the future.

Related Party Revenues

Donnelley Financial generates a portion of net revenue from sales to RRD’s subsidiaries. Net revenues from sales to RRD and affiliates of $1.1 million and $3.6 million for the three and nine months ended September 30, 2016, respectively, were included in the unaudited condensed combined statement of operations.

Related Party Purchases

Donnelley Financial utilizes RRD for freight and logistics and services as well as certain production of printed products.  Cost of sales of $11.5 million and $48.6 million for the three and nine months ended September 30, 2016, respectively, were included in the unaudited condensed combined statement of operations for these purchases.

Donnelley Financial also utilizes RRD’s business process outsourcing business for certain composition, XBRL and other functions.  Cost of sales of $8.7 million and $29.4 million for the three and nine months ended September 30, 2016, respectively, were included in the unaudited condensed combined statement of operations for these purchases. 

For periods prior to the Separation, intercompany payables with RRD and affiliates for these purchases are reflected within net parent company investment in the unaudited condensed consolidated and combined financial statements.

Share-Based Compensation Prior to Separation

Prior to the Separation, certain Donnelley Financial employees participated in RRD’s share-based compensation plans, the costs of which have been allocated to Donnelley Financial and recorded in selling, general and administrative expenses in the unaudited condensed combined statement of operations. Share-based compensation costs allocated to the Company were $0.2 million and $1.2 million for the three and nine months ended September 30, 2016, respectively. 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Retirement Plans Prior to Separation

Prior to the Separation, Donnelley Financial employees participated in pension and other postretirement plans sponsored by RRD.  These costs are reflected in the Company’s cost of sales and selling, general and administrative expenses in the unaudited condensed consolidated and combined statements of operations.  These costs were funded through intercompany transactions with RRD which are reflected within the net parent company investment.

On October 1, 2016, Donnelley Financial recorded net pension plan liabilities of $68.3 million (consisting of a total benefit plan liability of $317.0 million, net of plan assets having fair market value of $248.7 million), as a result of the transfer of certain pension plan liabilities and assets from RRD to the Company upon the legal split of those plans. The pension plan asset allocation from RRD was finalized on June 30, 2017, which resulted in a $0.7 million decrease to the fair value of plan assets transferred to the Company from RRD. Refer to Note 6, Retirement Plans, for further details regarding the Company’s pension and other postretirement benefit plans.

Centralized Cash Management Prior to Separation

RRD used a centralized approach to cash management and financing of operations.  Prior to the Separation, the majority of the Company’s foreign subsidiaries were party to RRD’s international cash pooling arrangements to maximize the availability of cash for general operating and investing purposes.  As part of RRD’s centralized cash management process, cash balances were swept regularly from the Company’s accounts.  Cash transfers to and from RRD’s cash concentration accounts and the resulting balances at the end of each reporting period prior to the Separation are reflected in net parent company investment in the consolidated balance sheet.  

Debt

RRD’s third party debt and related interest expense have not been allocated to the Company for any of the periods presented as the Company was not the legal obligor of the debt and the borrowings were not directly related to the Company’s business.

 

Note 14. New Accounting Pronouncements  

In March 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2017-07 “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”), which requires an employer to report the service cost component of net periodic benefit cost in the same line item(s) as other employee compensation costs arising from services rendered during the period. The other components of net periodic benefit cost will be presented in the income statement separately from the line item(s) that includes the service cost and outside of any subtotal of operating income. ASU 2017-07 must be applied retrospectively and is effective in the first quarter of 2018. Early adoption is permitted; however the Company plans to adopt the standard in the first quarter of 2018. Refer to Note 6, Retirement Plans, for disclosure of pension income for the nine months ended September 30, 2017 and 2016 which would be reclassified to other income upon adoption of the standard.

In January 2017, the FASB issued Accounting Standards Update No. 2017-04 “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”), which simplifies the accounting for goodwill impairment. ASU 2017-04 requires entities to record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (Step 1 under the current impairment test). The standard eliminates Step 2 from the current goodwill impairment test, which included determining the implied fair value of goodwill and comparing it with the carrying amount of that goodwill. ASU 2017-04 must be applied prospectively and is effective in the first quarter of 2020. Early adoption is permitted. The Company early adopted the standard in the first quarter of 2017.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 “Leases (Topic 842)” (“ASU 2016-02”), which requires lessees to put most leases on the balance sheet but recognize expense on the income statement in a manner similar to current accounting. For lessors, ASU 2016-02 also modifies the classification criteria and the accounting for sales-type and direct financing leases. The standard requires a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements and is effective in the first quarter of 2019. Early adoption of ASU 2016-02 is permitted; however the Company plans to adopt the standard in the first quarter of 2019. The Company is evaluating the impact of ASU 2016-02.

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which outlines a single comprehensive model for entities to use in accounting for revenue using a five-step process that supersedes virtually all existing revenue guidance. ASU 2014-09 also requires additional quantitative and qualitative disclosures. In August 2015, the FASB issued Accounting Standards Update No. 2015-14 “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date” (“ASU 2015-14”), which defers the effective date of ASU 2014-09 to January 1, 2018. Early adoption of ASU 2014-09 is permitted in the first quarter of 2017.  However, the Company plans to adopt the standard in the first quarter of 2018. The standard allows the option of either a full retrospective adoption, meaning the standard is applied to all periods presented, or a modified retrospective adoption, meaning the standard is applied only to the most current period. The Company is evaluating the impact of the provisions of ASU 2014-09 and currently anticipates applying the modified retrospective approach when adopting the standard.

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

 

Note 15. Guarantor Financial Information  

As described in Note 11, Debt, on September 30, 2016, the Company issued the Notes.  The Guarantors of the Notes, Donnelley Financial, LLC and DFS International Holding, Inc., entered into an agreement pursuant to which each agreed to guarantee the Company’s obligations under the Notes. All guarantees are full and unconditional and joint and several. The Guarantors are 100% directly owned subsidiaries of the Company.

The guarantee of the Notes by a subsidiary guarantor will be automatically released under certain situations, including upon the sale or disposition of such subsidiary guarantor to a person that is not Donnelley Financial or a subsidiary guarantor of the notes, the liquidation or dissolution of such subsidiary guarantor, and if such subsidiary guarantor is released from its guarantee obligations under the Company’s Credit Facilities.

The following tables set forth condensed consolidating statements of income for the three and nine months ended September 30, 2017 and 2016, condensed consolidating statements of financial position as of September 30, 2017 and December 31, 2016, and condensed consolidating and combined statements of cash flows for the nine months ended September 30, 2017 and 2016. The principal consolidating adjustments are to eliminate the investment in subsidiaries and intercompany balances and transactions. For purposes of the tables below, the Company is referred to as “Parent” and the Guarantors are referred to as “Guarantor Subsidiaries.”

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Operations

For the Three Months Ended September 30, 2017

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Operations

For the Nine Months Ended September 30, 2017

 

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Operations

For the Three Months Ended September 30, 2016

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Operations

For the Nine Months Ended September 30, 2016

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Balance Sheet

As of September 30, 2017

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Balance Sheet

As of December 31, 2016

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 30, 2017

 

 

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Donnelley Financial Solutions, Inc.

Notes to the Unaudited Condensed Consolidated and Combined Financial Statements

(in millions, except per share data, unless otherwise indicated)

 

 

Condensed Consolidating Statements of Cash Flows

For the Nine Months Ended September 30, 2016

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Company Overview

Donnelley Financial Solutions, Inc. (“Donnelley Financial,” or the “Company”) is a financial communications services company that supports global capital markets compliance and transaction needs for its corporate clients and their advisors (such as law firms and investment bankers) and global investment management compliance and analytics needs for mutual fund companies, variable annuity providers and broker/dealers. The Company provides content management, multi-channel content distribution, data management and analytics services, collaborative workflow and business reporting tools, and translations and other language services in support of its clients’ communications requirements. The Company operates in two business segments:

The Company reports certain unallocated selling, general and administrative activities and associated expenses within “Corporate”, including, in part, executive, legal, finance, marketing and certain facility costs. In addition, certain costs and earnings of employee benefit plans, such as pension income and share-based compensation, are included in Corporate and are not allocated to the reportable segments. Prior to the Separation (as defined below), many of these costs were based on allocations from R.R. Donnelley & Sons Company (“RRD”); however, the Company now incurs such costs directly.

For the Company’s financial results and the presentation of certain other financial information by segment, see Note 10, Segment Information, to the Unaudited Condensed Consolidated and Combined Financial Statements.

Products and Services

The Company separately reports its net sales and related cost of sales for its products and services offerings. The Company’s services offerings consist of all non-print offerings, including document composition, compliance related EDGAR filing services, transaction solutions, data and analytics, content storage services and language solutions. The Company’s product offerings primarily consist of conventional and digital printed products and related distribution costs.

Spin-off Transaction

On October 1, 2016, Donnelley Financial became an independent publicly traded company through the distribution by RRD of approximately 26.2 million shares, or 80.75%, of Donnelley Financial common stock to RRD shareholders (the “Separation”). Holders of RRD common stock received one share of Donnelley Financial common stock for every eight shares of RRD common stock held on September 23, 2016. RRD retained approximately 6.2 million shares of Donnelley Financial common stock, or a 19.25% interest (as of the Separation date) in Donnelley Financial, as part of the Separation.

Donnelley Financial’s common stock began regular-way trading under the ticker symbol “DFIN” on the New York Stock Exchange on October 3, 2016. On October 1, 2016, RRD also completed the previously announced separation of LSC Communications, Inc. (“LSC”), its publishing and retail-centric print services and office products business. On March 28, 2017, RRD completed the sale of 6.2 million shares of LSC common stock (RRD’s remaining ownership stake in LSC) in an underwritten public offering. As a result, beginning in the quarter ended June 30, 2017, LSC is no longer an affiliate of the Company.  

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On March 24, 2017, pursuant to the Stockholder and Registration Rights Agreement, the Company filed a Registration Statement on Form S-1 to register the offering and sale of the Company’s common stock retained by RRD. The Registration Statement on Form S-1, as amended, was declared effective by the SEC on June 13, 2017. On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. RRD retained approximately 0.1 million shares of the Company’s common stock upon consummation of the offering which were subsequently sold by RRD on August 1, 2017. In conjunction with the underwritten public offering, the underwriters exercised their option to purchase approximately 0.9 million of the Company’s shares (the “Option Shares”). The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. The proceeds were used to reduce outstanding debt under the Revolving Facility (as defined in Liquidity and Capital Resources).

Beginning in the quarter ended September 30, 2017, RRD no longer qualified as a related party, therefore amounts disclosed related to RRD are presented through June 30, 2017 only.

Executive Overview

Third Quarter Overview

Net sales decreased by $1.8 million, or 0.8%, for the third quarter of 2017 compared to the same period in the prior year. There was a $0.3 million, or 0.1%, increase due to changes in foreign exchange rates. Net sales decreased primarily due to lower volumes in capital markets transactions, partially offset by higher volumes in mutual fund print and print-related services and capital markets compliance.

Non-GAAP Measures

The Company believes that certain Non-GAAP measures, such as Non-GAAP adjusted EBITDA, provide useful information about the Company’s operating results and enhance the overall ability to assess the Company’s financial performance.  The Company uses these measures, together with other measures of performance under GAAP, to compare the relative performance of operations in planning, budgeting and reviewing the performance of its business.  Non-GAAP adjusted EBITDA allows investors to make a more meaningful comparison between the Company’s core business operating results over different periods of time.  The Company believes that Non-GAAP adjusted EBITDA, when viewed with the Company’s results under GAAP and the accompanying reconciliations, provides useful information about the Company’s business without regard to potential distortions. By eliminating potential differences in results of operations between periods caused by factors such as depreciation and amortization methods, historic cost and age of assets, financing and capital structures, taxation positions or regimes, restructuring, impairment and other charges and gain or loss on certain equity investments and asset sales, the Company believes that Non-GAAP adjusted EBITDA can provide a useful additional basis for comparing the current performance of the underlying operations being evaluated.

Non-GAAP adjusted EBITDA is not presented in accordance with GAAP and has important limitations as an analytical tool. These measures should not be considered as a substitute for analysis of the Company’s results as reported under GAAP. In addition, these measures are defined differently by different companies in our industry and, accordingly, such measures may not be comparable to similarly-titled measures of other companies.

In addition to the factors listed above, the following items are excluded from Non-GAAP adjusted EBITDA:

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A reconciliation of GAAP net earnings to Non-GAAP adjusted EBITDA for the three and nine months ended September 30, 2017 and 2016 for these adjustments is presented in the following table:

 

 

2017 Restructuring, impairment and other charges—net. The three months ended September 30, 2017 included $0.4 million for employee termination costs and a $1.0 million net reversal of other restructuring charges, primarily related to the reversal of previously recognized lease termination costs associated with a facility that the Company began using during the third quarter of 2017. The nine months ended September 30, 2017 included $5.2 million for employee termination costs, $0.9 million of net lease termination and other restructuring costs, $0.2 million of net impairment charges of long-lived assets and $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.

2016 Restructuring, impairment and other charges—net. The three months ended September 30, 2016 included $1.3 million for employee termination costs and $0.4 million of lease termination and other restructuring costs. The nine months ended September 30, 2016 included $2.3 million for employee termination costs, $1.2 million of lease termination and other restructuring costs and $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.

Share-based compensation expense. Included pre-tax charges of $1.7 million and $0.2 million for the three months ended September 30, 2017 and 2016, respectively, and $5.2 million and $1.2 million for the nine months ended September 30, 2017 and 2016, respectively.

Spin-off related transaction expenses. Included pre-tax charges of $2.6 million and $9.8 million related to third-party consulting fees, legal fees and other costs related to the Separation for the three months and nine months ended September 30, 2017, respectively.

OUTLOOK

Competition

Technological and regulatory changes, including the electronic distribution of documents and data hosting of media content, continue to impact the market for our products and services. One of the Company’s competitive strengths is that it offers a wide array of communications products, compliance services and technologies, a global platform, exceptional sales and service and regulatory domain expertise, which provide differentiated solutions for its clients.

The financial communications services industry, in general, is highly competitive and barriers to entry have decreased as a result of technology innovation.   Despite some consolidation in recent years, the industry remains highly fragmented in the United States and even more so internationally with many in-country alternative providers. The Company expects competition to increase from existing competitors, as well as new and emerging market entrants. In addition, as the Company expands its product and service offerings, it may face competition from new and existing competitors. The Company competes primarily on product quality and functionality, service levels, subject matter regulatory expertise, security and compliance characteristics, price and reputation.

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The impact of digital technologies has been felt in many print products, most acutely in the Company’s mutual fund, variable annuity and public company compliance business offerings.  Historically, the Company has been a high-touch, service oriented business. Technology changes have provided alternatives to the Company’s clients that allow them to manage more of the financial disclosure process themselves through collaborative document management solutions.  For years, the Company has invested in its own applications, ActiveDisclosure, FundSuiteArc and Venue to serve clients and increase retention and has invested to expand capabilities and address new market sectors. The future impact of technology on the business is difficult to predict and could result in additional expenditures to restructure impacted operations or develop new technologies. In addition, the Company has made targeted acquisitions and investments in its existing business to offer clients innovative services and solutions, including acquisitions of EDGAR Online and MultiCorpora and investments in Soxhub, Mediant, Peloton and eBrevia that further solidify the Company’s position as a technology service leader in the industry.  

The Company’s competitors for SEC filing services for capital markets clients include full service financial communications providers, technology point solution providers focused on financial communications and general technology providers. The Company’s competitors for SEC filing services for investment markets clients include full service traditional providers, small niche technology providers and local and regional print providers that bid against the Company for printing, mailing and fulfillment services.  Language solutions competes with global and local language service providers and language/globalization software vendors.

Market Volatility/Cyclicality

The Company is subject to market volatility in the United States and world economy, as the success of the transactional offering is largely dependent on the global market for IPOs, secondary offerings, mergers and acquisitions, public and private debt offerings, leveraged buyouts, spinouts and other transactions. The International segment is particularly susceptible to capital market volatility as most of the International business is capital markets transaction focused. The Company mitigates some of that risk by offering services in higher demand during a down market, like document management tools for the bankruptcy/restructuring process, and also moving upstream from the filing process with products like Venue, the Company’s data room solution. The Company also attempts to balance this volatility through supporting the quarterly/annual public company reporting process through its EDGAR filing services and ActiveDisclosure product, its investment markets regulatory and shareholder communications offering and continues to expand into adjacent growth businesses like language solutions and data and analytics, which have recurring revenues and are not as susceptible to market volatility and cycles. This quarterly/annual public company reporting process work also subjects the Company to filing seasonality shortly after the end of each fiscal quarter, with peak periods during the course of the year that have operational implications. Such operational implications include the need to increase staff during peak periods through a combined strategy of hiring additional full-time and temporary personnel, increasing the premium time of existing staff, and outsourcing production for a number of services. Additionally, clients and their financial advisors have begun to increasingly rely on web-based services which allow clients to autonomously file and distribute compliance documents with regulatory agencies, such as the SEC. While the Company believes that its ActiveDisclosure and FundSuiteArc solutions are competitive in this space, competitors are continuing to develop technologies that aim to improve clients’ ability to autonomously produce and file documents to meet their regulatory obligations. The Company continues to remain focused on driving recurring revenue in order to mitigate market volatility.

Raw Materials

The primary raw materials used in the Company’s printed products are paper and ink. The paper and ink supply is sourced from a small set of select suppliers in order to ensure consistent quality that meets the Company’s performance expectations and provides for continuity of supply. The Company believes that the risk of incurring material losses as a result of a shortage in raw materials is unlikely and that the losses, if any, would not have a materially negative impact on the Company’s business.

Distribution

The Company’s products are distributed to end-users through the U.S or foreign postal services, through retail channels, electronically or by direct shipment to customer facilities. Postal costs are a significant component of many customers’ cost structures and postal rate changes can influence the number of pieces that the Company’s customers are willing to print and mail.

Financial Review

In the financial review that follows, the Company discusses its unaudited condensed consolidated and combined results of operations, cash flows and certain other information. In periods prior to the Separation, the combined financial statements were prepared on a stand-alone basis and were derived from RRD’s consolidated financial statements and accounting records. There are limitations inherent in the preparation of all carve out financial statements due to the fact that the Company’s business was previously part of a larger organization. This discussion should be read in conjunction with the Company’s unaudited condensed consolidated and combined financial statements and the related notes.

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Results of Operations for the Three Months Ended September 30, 2017 as Compared to the Three Months Ended September 30, 2016

The following table shows the results of operations for the three months ended September 30, 2017 and 2016 :

 

 

 

Consolidated and Combined

Net sales of services for the three months ended September 30, 2017 increased $0.9 million, or 0.6%, to $140.3 million, versus the three months ended September 30, 2016, including a $0.2 million, or  0.1%, increase due to changes in foreign exchange rates. Net sales of services increased due to higher mutual fund print-related services and virtual data room services, partially offset by lower volumes in both capital markets transactions and compliance and mutual fund content management volumes.

Net sales of products for the three months ended September 30, 2017 decreased $2.7 million, or 3.2%, to $82.3 million versus the three months ended September 30, 2016, including a $0.1 million, or 0.1%, increase due to changes in foreign exchange rates. Net sales of products decreased due to lower capital markets transactions volumes and healthcare print volumes, partially offset by higher capital markets compliance volumes.

Services cost of sales increased $8.8 million, or 12.1%, for the three months ended September 30, 2017, versus the three months ended September 30, 2016. Services cost of sales increased due to higher volumes in mutual fund print-related services, an increase in the allocation of information technology expenses from selling, general and administrative expenses to cost of sales, partially offset by cost control initiatives. As a percentage of net sales, services cost of sales increased 5.9% primarily due to unfavorable mix from lower capital markets transaction volumes and increased information technology expenses.

Products cost of sales decreased $14.6 million, or 19.9%, for the three months ended September 30, 2017, versus the three months ended September 30, 2016. As a percentage of net sales, products cost of sales decreased 14.9%. Products cost of sales decreased due to a favorable mix of products sales and cost control initiatives.

Selling, general and administrative expenses increased $5.5 million, or 11.3%, to $54.0 million, for the three months ended September 30, 2017, as compared to the three months ended September 30, 2016, primarily due to an increase in expenses incurred to operate as an independent public company, including employee compensation costs and spin-off related transaction expenses, partially offset by an increase in the allocation of information technology expenses from selling, general and administrative expenses to cost of sales. As a percentage of net sales, selling, general, and administrative expenses increased from 21.6% for the three months ended September 30, 2016 to 24.3% for the three months ended September 30, 2017 due to increased costs of operating as an independent public company.

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For the three months ended September 30, 2017, the Company recorded a net restructuring reversal of $0.6 million, as compared to $1.7 million in expense for the three months ended September 30, 2016. In 2017, the net restructuring reversal included a $1.0 million net restructuring reversal of other restructuring charges, primarily related to the reversal of previously recognized lease termination charges associated with a facility that the Company began using during the third quarter of September 30, 2017 partially offset by $0.4 million of employee termination costs for 21 employees. In 2016, these charges included $1.3 million of employee termination costs for 22 employees and $0.4 million of lease termination and other restructuring costs.

Depreciation and amortization increased $0.8 million, or 8.2%, to $10.6 million for the three months ended September 30, 2017 compared to the three months ended September 30, 2016.  Depreciation and amortization included $3.6 million and $3.6 million of amortization of other intangible assets related to customer relationships, trade names and non-compete agreements for the three months ended September 30, 2017 and 2016, respectively.

Income from operations for the three months ended September 30, 2017 was consistent at $18.0 million as compared to the three months ended September 30, 2016, due to cost control initiatives and higher volumes in capital markets compliance, mutual fund print-related services and virtual data room services, partially offset by lower volumes in capital markets transactions and healthcare print, an increase in expenses incurred to operate as an independent public company, including employee compensation costs and spin-off related transaction expenses.

 

 

Net interest expense increased $10.7 million for the three months ended September 30, 2017 versus the same period in 2016, due to the issuance of debt in connection with the Separation.

 

 

The effective income tax rate was 28.4% for the three months ended September 30, 2017 compared to 43.6% for the three months ended September 30, 2016.  For the quarter ended September 30, 2017, the effective income tax rate is lower due to a decrease in the estimated full-year income tax rate, which was driven by a favorable change in jurisdictional mix of income, as well as the positive settlement of previous years’ tax disputes.

Information by Segment

The following tables summarize net sales, income (loss) from operations and certain items impacting comparability within each of the operating segments and Corporate.

U.S.

 

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Net sales for the U.S. segment for the three months ended September 30, 2017 were $186.1 million, a decrease of $6.2 million, or 3.2%, compared to the three months ended September 30, 2016.  Net sales decreased due to lower volumes in capital markets transactions and healthcare print, partially offset by higher capital markets compliance volumes, mutual fund print-related services, and virtual data room services. An analysis of net sales by reporting unit follows:

U.S. segment income from operations increased $3.7 million, or 19.8%, for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016, primarily due to an increase in capital markets compliance volumes, mutual fund print-related services, cost control initiatives, and lower restructuring, impairment and other charges, partially offset by lower volumes in capital markets transactions, spin-off related transaction expenses and lower healthcare volumes.  

Operating margins increased from 9.7% for the three months ended September 30, 2016 to 12.0% for the three months ended September 30, 2017 due to cost control initiatives, partially offset by an increase in selling expenses and incentive compensation expense.    

International

 

 

Net sales for the International segment for the three months ended September 30, 2017 were $36.5 million, an increase of $4.4 million, or 13.7%, compared to the three months ended September 30, 2016 including a $0.3 million, or 0.9%, increase due to changes in foreign exchange rates. Net sales increased due to higher mutual fund print-related services and translation services.

International segment income from operations increased $0.4 million, or 36.4%, for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016, due to an increase in mutual fund print-related services and translation services and lower restructuring, impairment and other charges, partially offset by an increase in allocated expenses, including information technology expenses.

Operating margins increased from 3.4% for the three months ended September 30, 2016 to 4.1% for the three months ended September 30, 2017 due to an increase in overall sales volume for the segment, partially offset by an increase in allocated expenses, including information technology expenses.

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Corporate

The following table summarizes unallocated operating expenses and certain items impacting comparability within the activities presented as Corporate:

 

 

Corporate operating expenses for the three months ended September 30, 2017 increased $4.1 million versus the same period in 2016 due to higher employee compensation costs incurred to operate as an independent public company, an increase in share-based compensation expense and spin-off related transaction expenses.

Results of Operations for the Nine Months Ended September 30, 2017 as Compared to the Nine Months Ended September 30, 2016

The following table shows the results of operations for the nine months ended September 30, 2017 and 2016 :

 

 

 

 

Consolidated and Combined

Net sales of services for the nine months ended September 30, 2017 increased $17.3 million, or 3.8%, to $471.4 million, versus the nine months ended September 30, 2016, including a $2.4 million, or 0.5%, decrease due to changes in foreign exchange rates. Net sales of services increased due to higher volumes in mutual fund print-related services, virtual data room services and content management, partially offset by lower capital markets transactions and compliance volumes.

Net sales of products for the nine months ended September 30, 2017 increased $0.3 million, or 0.1%, to $308.7 million versus the nine months ended September 30, 2016, including a $1.0 million, or 0.3%, decrease due to changes in foreign exchange rates. Net sales of products increased due to higher capital markets compliance and mutual fund print-volumes, partially offset by lower capital markets transactions volumes and healthcare volumes.

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Services cost of sales increased $15.7 million, or 6.4%, for the nine months ended September 30, 2017, versus the nine months ended September 30, 2016. Services cost of sales increased due to higher mutual fund print-related services, and content management volumes, an increase in the allocation of information technology expenses from selling, general and administrative expenses to cost of sales and an increase in incentive compensation expense, partially offset by cost control initiatives. As a percentage of net sales, services cost of sales increased 1.4% due to unfavorable mix and the increased information technology expense.

Products cost of sales decreased $5.5 million, or 2.4%, for the nine months ended September 30, 2017, versus the nine months ended September 30, 2016. As a percentage of net sales, products cost of sales decreased 1.9%.  Products cost of sales decreased due to a favorable mix of product sales and cost control initiatives.      

Selling, general and administrative expenses increased $14.4 million, or 9.2%, to $171.2 million, for the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016, primarily due to an increase in expenses incurred to operate as an independent public company, including selling expenses, employee compensation costs and spin-off related transaction expenses, partially offset by an increase in the allocation of information technology expenses from selling, general and administrative expenses to cost of sales. As a percentage of net sales, selling, general, and administrative expenses increased from 20.6% for the nine months ended September 30, 2016 to 21.9% for the nine months ended September 30, 2017 primarily due to increased costs of operating as an independent public company, including spin-off related transaction expenses.

For the nine months ended September 30, 2017, the Company recorded net restructuring, impairment and other charges of $6.4 million, as compared to $3.6 million for the nine months ended September 30, 2016.  In 2017, these charges included $5.2 million of employee termination costs for 169 employees, $0.9 million of lease termination and other restructuring costs, $0.2 million of impairment charges for long-lived assets, and $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.  In 2016, these charges included $2.3 million of employee termination costs for 74 employees, $1.2 million of lease termination and other restructuring costs and $0.1 million for other charges associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans serving facilities that continued to operate.

Depreciation and amortization increased $1.6 million, or 5.3%, to $31.7 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016.  Depreciation and amortization included $10.7 million and $10.8 million of amortization of other intangible assets related to customer relationships, trade names and non-compete agreements for the nine months ended September 30, 2017 and 2016, respectively.

Income from operations for the nine months ended September 30, 2017 decreased $11.4 million, or 11.5%, to $88.1 million versus the nine months ended September 30, 2016, due to lower volumes in capital markets transactions and healthcare print and an increase in expenses incurred to operate as an independent public company, including selling expenses, employee compensation costs and spin-off related transaction expenses, partially offset by cost control initiatives and higher volumes in mutual funds print-related, capital markets compliance, mutual fund print, virtual data room services, and content management.

 

 

Net interest expense increased $32.4 million for the nine months ended September 30, 2017 versus the same period in 2016, due to the issuance of debt in connection with the Separation.

 

 

The effective income tax rate was 39.7% for the nine months ended September 30, 2017 compared to 39.6% for the nine months ended September 30, 2016.  

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Information by Segment

The following tables summarize net sales, income (loss) from operations and certain items impacting comparability within each of the operating segments and Corporate.

U.S.

 

 

 

Net sales for the U.S. segment for the nine months ended September 30, 2017 were $658.2 million, a decrease of $4.2 million, or 0.6%, compared to the nine months ended September 30, 2016. Net sales decreased due to lower capital markets transactions and healthcare volumes partially offset by higher volumes in capital markets compliance, mutual fund print-related services, mutual fund print volumes, virtual data room services and content management. An analysis of net sales by reporting unit follows:

U.S. segment income from operations increased $7.5 million, or 7.5%, for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, due to cost control initiatives and higher volumes in capital markets compliance, mutual fund print-related services, mutual fund print volumes, virtual data room services and content management, partially offset by lower capital markets transactions and healthcare volumes and an increase in selling expenses, spin-off related transaction expenses, incentive compensation expense, and restructuring, impairment and other charges.

Operating margins increased from 15.1% for the nine months ended September 30, 2016 to 16.3% for the nine months ended September 30, 2017 due to cost control initiatives. The increase in operating margins was partially offset by spin-off related transaction expenses and higher restructuring, impairment and other charges which impacted margins by 0.6 and 0.2 percentage points, respectively, and an increase in selling expenses and incentive compensation expense.    

International

 

 

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Net sales for the International segment for the nine months ended September 30, 2017 were $121.9 million, an increase of $21.8 million, or 21.8%, compared to the nine months ended September 30, 2016 including a $3.4 million, or 3.4%, decrease due to changes in foreign exchange rates. Net sales increased due to higher volumes in capital markets transactions, mutual funds, virtual data room, and translation services.

International segment income from operations was $7.6 million and $7.2 million for the nine months ended September 30, 2017 and 2016, respectively, due to the increase from the higher volumes in capital markets transactions, mutual funds, virtual data room and translation services and cost control initiatives, mostly offset by an increase in allocated expenses, including information technology expenses and an increase in incentive compensation expense and restructuring, impairment and other charges.

Operating margins decreased from 7.2% for the nine months ended September 30, 2016 to 6.2% for the nine months ended September 30, 2017 of which 0.6 percentage points were due to higher restructuring, impairment and other charges.  Operating margins were also impacted by an increase in allocated expenses, including information technology expenses partially offset by cost control initiatives.

Corporate

The following table summarizes unallocated operating expenses and certain items impacting comparability within the activities presented as Corporate:

 

 

Corporate operating expenses for the nine months ended September 30, 2017 increased $19.3 million versus the same period in 2016 due to higher employee compensation costs incurred to operate as an independent public company, spin-off related transaction expenses and an increase in share-based compensation and bad debt expense.

Liquidity and Capital Resources  

Prior to the Separation, RRD provided financing, cash management and other treasury services to Donnelley Financial. The Company’s cash balances were swept by RRD and the Company received funding from RRD for operating and investing needs. Cash transferred to and from RRD was recorded as intercompany payables and receivables which are reflected in the net parent company investment in the consolidated and combined financial statements. Subsequent to the Separation, the Company no longer participates in cash management and funding arrangements with RRD.

The Company believes it has sufficient liquidity to support its ongoing operations and to invest in future growth to create value for its shareholders. Cash on hand, operating cash flows and the Company’s $300.0 million senior secured revolving credit facility (the “Revolving Facility”) are the primary sources of liquidity and are expected to be used for, among other things, payment of interest and principal on the Company’s debt obligations, capital expenditures necessary to support productivity improvement and growth, acquisitions and completion of restructuring programs.

The following describes the Company’s cash flows for the nine months ended September 30, 2017 and 2016.

Cash Flows Used For Operating Activities

Operating cash inflows are largely attributable to sales of the Company’s services and products. Operating cash outflows are largely attributable to recurring expenditures for labor, rent, raw materials and other operating activities. For periods prior to the Separation, allocations of operating expenses from RRD are also reflected as operating cash inflows or outflows, including those for pension costs and current income taxes payable.

Net cash provided by operating activities was $33.7 million for the nine months ended September 30, 2017 compared to $56.8 million for the nine months ended September 30, 2016. The decrease in net cash provided by operating activities reflected higher payments related to interest and the timing of payments for suppliers and employee-related liabilities, offset by the timing of customer payments.

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Cash Flows Used For Investing Activities

Net cash used in investing activities was $23.1 million for the nine months ended September 30, 2017 compared to $17.0 million for the nine months ended September 30, 2016.  Capital expenditures were $20.0 million during the nine months ended September 30, 2017, an increase of $6.0 million as compared to the nine months ended September 30, 2016. The Company expects that capital expenditures for 2017 will be approximately $30.0 million to $35.0 million, compared to $26.2 million in 2016.

Cash Flows Provided By Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2017 was $15.2 million compared to $6.1 million for the nine months ended September 30, 2016. The increase in net cash used in financing activities reflected $100.0 million in payments on long-term debt partially offset by a $68.0 million Separation-related payment from RRD and $18.8 million of proceeds from the issuance of common stock as compared to $348.2 million of proceeds from issuance of long-term debt during the nine months ended September 30, 2016, mostly offset by $336.2 million in net transfers from RRD and its affiliates in connection with the Separation.

Contractual Cash Obligations and Other Commitments and Contingencies

In connection with the Separation, the Company entered into transition services agreements with RRD, covering certain support and back office services that the Company has historically received from RRD. Under the terms of the agreements, RRD will provide various services, including information technology, accounts receivable, accounts payable, payroll and other financial and administrative services and functions. The Company also entered into a transition services agreement with LSC, pursuant to which LSC will provide certain services to the Company. The services under the transition services agreements generally extend for up to 24 months following the Separation.

The Company entered into a number of commercial and other arrangements with RRD and its subsidiaries. These include, among other things, arrangements for the provision of services, including global outsourcing and logistics services, printing and binding, digital printing, composition and access to technology. The Company also entered into a number of commercial and other arrangements with LSC and its subsidiaries, pursuant to which LSC will print and bind products for the Company. The terms of the arrangements with RRD and LSC do not exceed 24 months.

See discussion in Liquidity related to the Company's debt obligations.

Liquidity

Cash and cash equivalents of $32.2 million at September 30, 2017 included $21.5 million in the U.S. and $10.7 million at international locations. The Company has not recognized deferred tax liabilities related to taxes on foreign earnings as foreign earnings are considered to be indefinitely reinvested. Certain cash balances of foreign subsidiaries may be subject to U.S. or local country taxes if repatriated to the U.S. In addition, repatriation of some foreign cash balances is further restricted by local laws. Management regularly evaluates whether foreign earnings are expected to be indefinitely reinvested. This evaluation requires judgment about the future operating and liquidity needs of the Company and its foreign subsidiaries. Changes in economic and business conditions, foreign or U.S. tax laws, or the Company’s financial situation could result in changes to these judgments and the need to record additional tax liabilities.

On June 21, 2017, RRD completed the sale of approximately 6.1 million shares of the Company’s common stock in an underwritten public offering. RRD retained approximately 0.1 million shares of the Company’s common stock upon consummation of the offering which were subsequently sold by RRD on August 1, 2017. In conjunction with the underwritten public offering, the underwriters exercised their option to purchase approximately 0.9 million Option Shares. The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. The proceeds were used to reduce outstanding debt under the Revolving Facility.

Pursuant to the Separation and Distribution Agreement, the Company received a cash payment of $68.0 million from RRD on April 3, 2017. The proceeds were used to reduce outstanding debt under the Term Loan Credit Facility.

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The Company’s debt maturity schedule as of September 30, 2017 is shown in the table below:

 

 

 

On October 2, 2017, the Company repriced the Term Loan Credit Facility. As a result, the interest rate was reduced by 100 basis points to LIBOR plus 3.0% and the LIBOR floor was reduced by 25 basis points to .75%. Additionally, under the amended Credit Agreement, principal payments are due on a quarterly basis. Other terms, including the outstanding principal, maturity date, and debt covenants such as the minimum interest coverage ratio and the maximum leverage ratio are consistent with the original Credit Agreement. If the debt maturity schedule above as of September 30, 2017 reflected the impact of the amended Credit Agreement, the Company would reflect the following amounts for Borrowings under the Term Loan Credit Facility:

 

 

The Credit Agreement contains a number of covenants, including, but not limited to, a minimum Interest Coverage Ratio and the Consolidated Leverage Ratio, as defined in and calculated pursuant to the Credit Agreement, that, in part, restrict the Company’s ability to incur additional indebtedness, create liens, engage in mergers and consolidations, make restricted payments and dispose of certain assets. The Credit Agreement generally allows annual dividend payments of up to $15.0 million in aggregate, though additional dividends may be allowed subject to certain conditions. Each of these covenants is subject to important exceptions and qualifications.

The indenture governing the Notes contains certain covenants applicable to the Company and its restricted subsidiaries, including limitations on: (1) liens; (2) indebtedness; (3) mergers, consolidations and acquisitions; (4) sales, transfers and other dispositions of assets; (5) loans and other investments; (6) dividends and other distributions, stock repurchases and redemptions and other restricted payments; (7) restrictions affecting subsidiaries; (8) transactions with affiliates; and (9) designations of unrestricted subsidiaries. Each of these covenants is subject to important exceptions and qualifications.

As of September 30, 2017, there were no outstanding borrowings under the Revolving Facility. Based on the Company’s results of operations for the twelve months ended September 30, 2017 and existing debt, the Company would have had the ability to utilize $261.0 million of the $300.0 million Revolving Facility and not have been in violation of the terms of the agreement. The current availability under the Revolving Facility and net available liquidity as of September 30, 2017 is shown in the table below:

 

 

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The Company was in compliance with its debt covenants as of September 30, 2017, and expects to remain in compliance based on management’s estimates of operating and financial results for 2017 and the foreseeable future.  However, declines in market and economic conditions or demand for certain of the Company’s products and services could impact the Company’s ability to remain in compliance with its debt covenants in future periods.  As of September 30, 2017, the Company met all the conditions required to borrow under the Credit Agreement and management expects the Company to continue to meet the applicable borrowing conditions.

The failure of a financial institution supporting the Revolving Facility would reduce the size of the Company’s committed facility unless a replacement institution was added. As of September 30, 2017, the Revolving Facility is supported by seventeen U.S. and international financial institutions.

As of September 30, 2017, the Company had $4.2 million in outstanding letters of credit and bank guarantees, of which there was no reduction to the availability under the Revolving Facility.

The Company’s liquidity may be affected by its credit ratings. The Company’s S&P and Moody’s credit ratings as of September 30, 2017 are shown in the table below:

 

 

Debt Issuances

On September 30, 2016, the Company entered into the Credit Agreement, which provided for the Term Loan Credit Facility and the Revolving Facility. The Term Loan Facility will mature on September 30, 2023 and the Revolving Credit Facility will mature on September 30, 2021.

On September 30, 2016, the Company issued $300.0 million of 8.250% Senior Notes (the “Notes”) due October 15, 2024.  Interest on the Notes is due semi-annually on April 15 and October 15, commencing on April 15, 2017.  

The Notes were issued pursuant to an indenture where certain wholly-owned domestic subsidiaries of the Company guarantee the Notes (the “Guarantors”).  In connection with the offering of the Notes, the Company entered into a registration rights agreement, dated as of September 30, 2016 (the “Registration Rights Agreement”), pursuant to which the Company agreed to file a registration statement with the SEC with respect to an offer to exchange the Notes for registered notes. On March 10, 2017, the Company filed a Registration Statement on Form S-4 (as amended, the “Exchange Offer Registration Statement”) to offer to exchange the Notes for registered notes which have terms identical in all material respects to the Notes except that the registered notes are not subject to transfer restrictions or registration rights. The Exchange Offer Registration Statement was declared effective by the SEC on March 22, 2017. An exchange offer for the Notes was launched on March 22, 2017 and settled on April 25, 2017, resulting in the exchange of $299.9 million aggregate principal amount of outstanding Notes for registered notes.

Risk Management

The Company is exposed to interest rate risk on its variable debt.  At September 30, 2017, the Company’s exposure to rate fluctuations on variable-interest borrowings was $198.5 million.

The Company assesses market risk based on changes in interest rates utilizing a sensitivity analysis that measures the potential loss in earnings, fair values and cash flows based on a hypothetical 10% change in interest rates. Using this sensitivity analysis, such changes would not have a material effect on interest income or expense and cash flows. A hypothetical 10% change in yield would change the fair values of fixed-rate debt at September 30, 2017 by approximately $11.7 million, or 3.9%.

The Company is exposed to the impact of foreign currency fluctuations in certain countries in which it operates. The exposure to foreign currency movements is limited in many countries because the operating revenues and expenses of its various subsidiaries and business units are substantially in the local currency of the country in which they operate. To the extent that borrowings, sales, purchases, revenues, expenses or other transactions are not in the local currency of the subsidiary, the Company is exposed to currency risk and may enter into foreign exchange spot and forward contracts to hedge the currency risk. The Company does not use derivative financial instruments for trading or speculative purposes.

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OTHER INFORMATION

Litigation and Contingent Liabilities

For a discussion of certain litigation involving the Company, see Note 12, Commitments and Contingencies, to the Unaudited Condensed Consolidated and Combined Financial Statements.

New Accounting Pronouncements and Pending Accounting Standards

Recently issued accounting standards and their estimated effect on the Company’s combined financial statements are described in Note 14, New Accounting Pronouncements, to the Unaudited Condensed Consolidated and Combined Financial Statements.

CAUTIONARY STATEMENT

The Company has made forward-looking statements in this Quarterly Report on Form 10-Q within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of the Company. Generally, forward-looking statements include information concerning possible or assumed future actions, events, or results of operations of the Company.

These statements may include words such as “anticipates,” “estimates,” “expects,” “projects,” “forecasts,” “intends,” “plans,” “continues,” “believes,” “may,” “will,” “goals” and variations of such words and similar expressions are intended to identify our forward-looking statements.

Forward-looking statements are not guarantees of performance. The following important factors, in addition to those discussed elsewhere in this Quarterly Report on Form 10-Q, that could cause our actual results to differ materially from those indicated in any such forward-looking statements. These factors include, but are not limited to:

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Because forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Undue reliance should not be placed on such statements, which speak only as of the date of this document or the date of any document that may be incorporated by reference into this document.

Consequently, readers of the Quarterly Report on Form 10-Q should consider these forward looking statements only as the Company’s current plans, estimates and beliefs. The Company does not undertake and specifically declines any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. The Company undertakes no obligation to update or revise any forward-looking statements in this Quarterly Report on Form 10-Q to reflect any new events or any change in conditions or circumstances.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Refer to Item 2 of Part I under “Risk Management.” There have been no significant changes to the Company’s market risk since December 31, 2016. For a discussion of exposure to market risk, refer to Part II, Item 7A – Quantitative and Qualitative Disclosures about Market Risk, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on February 28, 2017.

 

 

Item 4. Controls and Procedures

Management, together with the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934) as of September 30, 2017. Based on that evaluation the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2017.

Under the rules and regulations of the Securities and Exchange Commission, Donnelley Financial is not required to comply with the requirements of Section 404 of the Sarbanes Oxley Act of 2002 until its Annual Report on Form 10-K for the year ending December 31, 2017. In its Annual Report on Form 10-K for the year ending December 31, 2017, management and the Company’s independent registered public accounting firm will be required to provide an assessment as to the effectiveness of the Company’s internal control over financial reporting.

There have not been any changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the quarter ended September 30, 2017 that had materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting. 

 

 

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

For a discussion of certain litigation involving the Company, see Note 12, Commitments and Contingencies, to the Condensed Consolidated and Combined Financial Statements.

 

 

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on February 28, 2017.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

 

Item 3. Defaults Upon Senior Securities

None.

 

 

Item 4. Mine Safety Disclosures

Not applicable.

 

 

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Item 6. Exhibits

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: November 2, 2017

 

 

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