Welcome to the DFIN Q1 earnings call. My name is John, I will be your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. During the question-and-answer session, if you do have a question, press star then one on your touch-tone phone. Please note the conference is being recorded. I'll now turn the call over to Justin Ritchie, Head of Investor Relations.
Thank you, John. Good morning, everyone, and thank you for joining the Donnelley Financial Solutions first quarter 2019 results conference call. This morning, we released our earnings report, a copy of which can be found in the Investors section of our website at dfinsolutions.com. During this call, we'll refer to forward-looking statements that are subject to uncertainty. For a complete discussion, please refer to the cautionary statements included in our earnings release and further detailed in our annual report on Form 10-K and other filings with the SEC. Further, we'll discuss non-GAAP financial information. We believe the presentation of non-GAAP financial information provides you with useful supplementary information concerning the company's ongoing operations and is an appropriate way for you to evaluate the company's performance. They are, however, provided for informational purposes only.
Please refer to the press release and related footnotes for GAAP financial information and a reconciliation of GAAP to non-GAAP financial information. I'm joined this morning by Dan Leib, Dave Gardella, Kami Turner, Tom Juhas, I will now turn the call over to Dan.
Thank you, Justin, good morning, everyone. As you saw in our press release this morning, 2019 began as we expected. With first quarter results reflecting a slow start to the year for our capital markets transactional offerings, driven by the lingering effects of fourth quarter market volatility, followed by the U.S. government shutdown. The year-over-year trends improved in each successive month within the quarter following the government reopening on January 25th. The capital markets transactional decline was partially offset by net sales growth in U.S. investment markets, where our year-over-year organic growth was 4%. Total SaaS net sales growth in the quarter was 6.5%, led by ActiveDisclosure, which grew 15.6%, driven by continued strong customer adoption.
While sales of our Venue data room were well below trend due to lower transactional activity early in the quarter, activity has since rebounded, and we expect performance to improve in the second quarter. Overall, we anticipate that we will achieve double-digit sales growth in our SaaS offerings for the full year, consistent with our longer-term trend and much stronger than we experienced in the first quarter. From an overall business mix perspective, we saw a shift toward more print-heavy net sales in the quarter, driven largely by a special proxy project in U.S. investment markets, as well as increased annual report volumes in U.S. capital markets. This, when coupled with year-over-year decline in transactional net sales and the temporary slowdown in SaaS growth, led to the decreased gross margins in the quarter.
Looking ahead, we anticipate gross margins improving in the second quarter as transactions continue to pick up and the mix shifts back towards higher margin tech-enabled services and SaaS revenue. First quarter organic net sales, which excludes the impact of the sale of the Language Solutions business, changes in foreign exchange rates, and the acquisition of eBrevia, were down 2.5% versus the first quarter of 2018, primarily driven by a 22% year-over-year decline in U.S. capital markets transactional net sales. As mentioned, market conditions for transactional-driven offerings were extremely challenging in January due to the lingering effects of recent market volatility and the government shutdown. In late February, we started to see improvement as companies began to reinitiate IPOs, debt offerings, and M&A deals. In March, we saw momentum gain and a return to more normalized market conditions.
Looking ahead, we enter the second quarter with positive momentum and a strong transactional pipeline, with IPOs being a bright spot offset by softer M&A. We see positive market trends, and our overall view for the year remains cautiously optimistic. As I mentioned, momentum picked up in March. DFIN is leading the IPO market, supporting numerous companies' debuts this quarter, including some of the largest high-profile filers to date. Following the government shutdown in January, companies are now starting to enter the markets more aggressively to ensure they're able to list this year. Our Venue virtual data room was recently named Global Data Room of the Year for the fourth year in a row by the Global M&A Network. Venue provides clients a highly secure data room platform that allows them to manage sensitive deal-related data, make complex financial transactions, and confidently share critical information in real time.
Venue users are also reaping the benefits of eBrevia's artificial intelligence technology in the form of more accurate data extraction and increased productivity, coupled with powerful encryption. The addition of eBrevia into our portfolio of end-to-end risk and compliance solutions has accelerated growth opportunities for DFIN within the legal, audit, consulting, and LPO verticals. Moving forward, we expect to explore additional opportunities as we continue to integrate the technology across the company. In fact, in just a few short months since the acquisition, we've already seen indications of this with expansions into engagements with global financial institutions. The regulatory and compliance space is evolving into the digital world, and we have the solutions to help our clients as they transition. What makes us different is that we couple our technology solutions with world-class service, a key differentiator for us and our clients.
We're leading our clients through industry transformation and giving them both the tools and support to confidently navigate an already complex environment. For example, in the first quarter, we saw dozens of clients adopt our user-friendly ActiveDisclosure platform that provides an end-to-end solution for financial reporting. Within our investment markets business, we had several key wins in the quarter, particularly with our proxy services, where we provide our clients leading-edge technology, an established global distribution network, and a team of dedicated experts to engage their shareholders and simplify their fund proxy management. Our FundSuite ARC software solution helps registered investment companies, private equity, hedge funds, and alternative investment companies produce annual, semiannual, quarterly, and other ad hoc reports. The technology makes it easy for clients by automating workflows and ingesting data from several different accounting systems and other client data sources to produce high-quality financial reporting.
A recent win, this one in the alternative investment space, involves implementing modules of our FundSuite ARC SaaS product for over 800 of their alternative investment funds over the course of this year. We also continue to focus on optimizing our solutions to support our clients in meeting critical dates like the upcoming N-PORT deadline on May 30th. Clients are currently filing with the SEC using our solution to automate and simplify the process. For example, we're pleased to announce that our team successfully filed the industry's first live N-PORT filing on behalf of one of the largest third-party fund administrators this April. With that, I'll turn it over to Dave to give more details on our financial performance. Dave?
Thank you, Dan, and good morning, everyone. Before I discuss our first quarter financial performance, I'd like to recap two significant items in the quarter that impact our year-over-year comparability. First, as we have discussed on the last two earnings calls, we completed the sale of our Language Solutions business in the third quarter of 2018. Our first quarter 2019 results exclude Language Solutions, while the first quarter of 2018 includes Language Solutions for the entire quarter. As I mentioned on the fourth quarter call, the sale negatively impacted our first quarter reported net sales comparison by $18.8 million and negatively impacted our gross profit and non-GAAP adjusted EBITDA comparisons by approximately $5.5 million and $1 million, respectively, inclusive of net stranded costs. Next, I'd like to recap a new accounting standard that we adopted during the first quarter of 2019.
As of January 1st, we adopted the new lease accounting standard, which requires lessees to put most leases on the balance sheet while continuing to recognize expense in the income statement in a manner similar to the former accounting standard. This resulted in the company recognizing a lease liability of $101.6 million and a right-of-use asset of $100.8 million for operating leases at January 1st, 2019. The company adopted the standard and all related amendments on January 1st, 2019, using the optional transition method. The comparative periods have not been restated and continue to be reported under the accounting standards in effect for those periods. The new lease accounting standard had no impact on the income statement. Keeping these items in mind, let's review the first quarter financial results.
On a consolidated basis, net sales for the first quarter of 2019 were $229.6 million, a decrease of $25.6 million, or 10%, from the first quarter of 2018, primarily due to the sale of Language Solutions and lower capital markets transactional activity. After adjusting for the sale of the Language Solutions business, changes in foreign exchange rates, and the acquisition of eBrevia, organic net sales decreased 2.5%. U.S. capital markets transactional net sales were down 22%, due in large part to the impact of the U.S. government shutdown. The impact of the decline in transactional net sales was largely offset by continued growth in our SaaS offerings, led by ActiveDisclosure, combined with a large non-recurring special proxy project in U.S. investment markets and growth in U.S. capital market compliance activity.
Adjusted for the sale of Language Solutions, services net sales in the first quarter decreased by $12.8 million, or 9.1%, as compared to the first quarter of 2018, driven by lower capital markets transactional activity, partially offset by continuing growth in our SaaS offerings. Products net sales increased by $6 million, or 6.3%, due to the increased volume in U.S. investment markets mutual fund and U.S. capital markets compliance activity that I mentioned earlier. First quarter gross margin was 33%, or 490 basis points lower than the first quarter of 2018, primarily driven by an unfavorable mix between higher margin services, including capital markets transactional net sales, and lower margin products net sales. Non-GAAP SG&A expense in the quarter was $52 million, $3.8 million lower than the first quarter of 2018.
As a percentage of revenue, Non-GAAP SG&A was 22.6%, up 70 basis points compared to the first quarter of 2018. The decrease in expense was primarily driven by the sale of Language Solutions and the impact of cost savings initiatives, partially offset by investments in support of our strategic priorities. Our first quarter Non-GAAP adjusted EBITDA was $23.7 million, a decrease of $17.1 million from the first quarter of 2018, primarily driven by the weak capital markets transactional activity and the sale of the Language Solutions business. As I noted earlier, the sale of the Language Solutions business negatively impacted first quarter EBITDA comparison by approximately $1 million. Weakness in the capital markets transactional activity also negatively impacted our Non-GAAP adjusted EBITDA margin in the quarter. Turning now to our segment results.
Net sales in our U.S. segment were $202.8 million in the first quarter of 2019, a decrease of 4.8% from last year's first quarter. On an organic basis, after adjusting for the sale of Language Solutions, the purchase of eBrevia, net sales declined 2.3%. Net sales in U.S. Capital Markets decreased 7.1% on an organic basis, due primarily to weak transactional activity. This was partially offset by net sales growth in U.S. Investment Markets, which increased 4% on an organic basis, primarily driven by a large special proxy project and timing shifts related to recurring revenue that was recognized in the second quarter last year, but in the first quarter this year. Non-GAAP adjusted EBITDA margin for the segment of 15.9% decreased 390 basis points from the first quarter of 2018, primarily due to lower U.S. capital markets transactional activity.
Net sales in our international segment were $26.8 million in the first quarter of 2019, a decrease of 36.3% from the first quarter of last year. On an organic basis, excluding the impact of the sale of the Language Solutions business and changes in foreign exchange rates, net sales in the first quarter were down 3.6% due to a decline in capital markets transactional activity, partially offset by continued SaaS growth in Europe. Non-GAAP adjusted EBITDA margin for the segment was negative 4.1%, reflective of the low level of capital markets transactional net sales. Our first quarter 2019 non-GAAP unallocated corporate expenses, excluding depreciation and amortization, were $7.4 million, an increase of $2.1 million from the first quarter of 2018. The increase was primarily driven by investment spending in support of our strategic priorities, partially offset by the impact of cost savings initiatives.
Consolidated free cash flow in the quarter was a use of $83.4 million, $23.4 million unfavorable to the first quarter of 2018. Relative to last year's first quarter, the higher use of cash was primarily driven by lower EBITDA stemming from the slowdown in transactional sales, the timing of various tax payments, as well as higher capital expenditures, including most of the digital print investment that I mentioned on our last call. This was partially offset by a benefit of working capital and lower interest payments related to our debt reduction. Our controllable working capital rate, which we define as accounts receivable plus inventory, less accounts payable as a % of our trailing three-month annualized net sales, was 16.6%, approximately flat to the first quarter of 2018.
We ended the first quarter with $411.7 million of total debt and $401.2 million of net debt, including $48.5 million drawn on our revolver, and we had net available liquidity of $123.1 million. As of March 31st, 2019, our net leverage ratio was 2.9 times, up 0.1 times from March 2018 and up 0.9 times from year-end 2018. The increase from year-end was partially driven by normal seasonality of our cash flow. We continue to target a gross leverage ratio in the range of 2.25 times to 2.75 times and expect to be below the low end of that range by the end of this year. As highlighted in this morning's press release, we are reiterating the full year guidance that we previously provided. While there is no change to our guidance, I will recap our expectations.
We expect 2019 total net sales to be in the range of $910 million-$940 million. We expect non-GAAP adjusted EBITDA to be in the range of $145 million-$155 million. Depreciation and amortization is expected to be approximately $48 million. We expect interest expense of approximately $35 million. Our full year non-GAAP effective tax rate is expected to be in the range of 29%-31%. We project the full year fully diluted weighted average share count to be approximately 35 million shares. Lastly, we expect capital expenditures in the range of $40 million-$45 million, with free cash flow also in the range of $40 million-$45 million. I also want to add a quick reminder regarding the impact of the Language Solutions sale on our upcoming quarters.
As noted in this morning's press release, the year-over-year negative impacts in the second quarter will be $19.8 million in net sales, $5.3 million in gross profit, and $1.5 million in non-GAAP adjusted EBITDA. Looking ahead to the third quarter, the year-over-year negative impacts will be $3.2 million in net sales, $1.2 million in gross profit, and $0.5 million in non-GAAP adjusted EBITDA. All of these impacts are inclusive of estimated net stranded costs and are included in our full-year guidance. Regarding seasonality, we are expecting second quarter net sales to be in the range of $260 million-$270 million, down approximately 2% year-over-year at the midpoint due to a softer M&A environment and this year's revenue timing shift from Q2 to Q1 in U.S. investment markets that I had mentioned earlier.
Regarding profitability, we expect that our non-GAAP EBITDA margin in the second quarter will be similar to the second quarter of 2018. Also with respect to timing, we expect most of the year-to-go growth to come in the fourth quarter, given the relatively easier comparison in Q4, a result of last year's market volatility. To summarize, as we expected, first quarter capital markets transactional activity was negatively impacted by the lingering effects of the fourth quarter market volatility and the U.S. government shutdown at the beginning of the quarter, steadily improving each month before returning to normalized levels in March. The net sales impact of the transactional slowdown was largely offset by net sales increases in our SaaS and other regulatory and compliance solutions. We have a strong transactional pipeline heading into the second quarter and positive momentum in the rest of the business.
As such, our full-year guidance remains unchanged. With that, I'll turn it back to Dan.
Thank you, Dave. We remain focused on our long-term strategic plan with a specific focus on our operating priorities, including changing the mix of business, protecting our current market position, and reshaping our culture. We will continue to seize opportunities to serve our clients when, where, and how they choose to work. As we execute on our strategy, we will remain disciplined around all capital deployment while appropriately investing in the business and maintaining our focus on delivering shareholder value. With that, let's open up the line for Q&A.
Thank you. We will now begin the question-and-answer session. If you do have a question, press star then one on your touch-tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. There will be a delay before the first question is announced. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, press star then one on your touch-tone phone. Our first question is from Charles Strauzer from CJS.
Hi. Good morning.
Morning, Charles.
Just looking at the transactional pipeline a little bit. You talked about being strong kind of heading into Q2. Obviously, there's some pretty high-profile IPOs still waiting to come to market. One of them you had talked about doing a direct listing in the New York Stock Exchange. Are you seeing any kind of a trend towards that more happening going forward in the pipeline? Also, does that impact the amount of work that you do with those companies?
Yes. Thanks, Charlie. We have not seen a large trend towards that. There are a few companies that have pursued that and a few more, as you mentioned, that rumored to be going down that path. Importantly, it does not change the requirements from the regulator of what needs to be done, and that's really what drives what we provide for our clients, as well as obviously process management and the technology in order to get things filed through the SEC. No impact to us. May have impact further up the chain in the IPO cycle, no impact to us.
You talked about M&A being a little bit softer than last year. Are you starting to see some of that improvement as you head into the middle of Q2 here?
Yes. We have seen M&A activity pick up. M&A typically has a relatively long lead time. As those deals pick up, and to Dave's comment on the back part of the year being where we see the lift given easier comps, some of that's embedded in that guidance, that's also what's driving that. Relative to Q2, we had a large deal last year that sat between Q2 and Q3. That has a bit of an impact relative to timing within the year.
Got it. Great. Just lastly, on the N-PORT deadline, I think you said it was, what, May 30th?
Correct.
Do you feel that the customers that you're talking to are ready for that deadline? If not, do you think there'll be an extension there?
We do. We feel good about our solution. We were first into the market, and we've made the right amount of investments, and we've had good success with clients. I think it is a lot more information and data that is being filed. There was a change made a couple of months back to push the deadline back a month, but we're not hearing anything relative to changing the deadline at this point.
Great. Thanks, guys.
Thank you.
Our next question is from Peter Heckmann from D.A. Davidson.
Good morning, gentlemen. Thanks for taking the question. Dan, could you go over those-
Morning, Pete.
Hey. Could you go over those ActiveDisclosure growth numbers, and then just elaborate a little bit? I thought you said dozens of wins, and I just wanted to make sure I understand what types of wins you're talking about there.
Sure. Yeah. ActiveDisclosure grew 15.6% in the quarter. As we talked over last year, we had good performance throughout the year last year, adding literally dozens of clients on a net basis each quarter. The way we look at it is, obviously, you have competitive wins and losses that flow amongst the various participants in the market. Then, there are non-competitive in terms of delistings or mergers and acquisitions and those sorts of things. On a net basis, we added roughly couple dozen logos in the first quarter. Consistently, as I mentioned last year, and really beginning in the back half of 2017, we've been adding about at that same pace, each quarter.
That's great. Would you attribute that to the investments that you've made in the functionality and the technology platform over the last two years? If so, I think you said, talked about potentially that level of spend plateauing here, for 2020. Is that still consistent with your expectations?
Yeah. Sure. I think it's a variety of factors, and I'll ask if Tom and Dave want to weigh in as well. From my perspective, our model of having the service network that stands behind is very helpful. Oftentimes what we're finding in ActiveDisclosure, and we're relatively late in this cycle where first movers may have moved over to, and more comfortable with a tech-only solution. We feel like the service that we can put around the technology is helpful, and desired by clients. We have a number of clients that at this point are relying solely on ActiveDisclosure, then we have other clients which are using a combination of the technology and relying on some of the service.
Clearly, incremental investment has helped, and if we take it up a level to your question on overall CapEx spending, Dave mentioned on the last call that we have an investment to digitize our print platform that is hitting in 2019. We don't expect to have that going forward. Then as we just look at overall CapEx, we do think that we're hitting a plateau, and we should see that number coming down moving forward.
Great. Just lastly before I get back in the queue, on the SG&A line, good decline there. You talked about seeing some of the cost efficiencies or cost saves materialize. So how are you thinking about that for the full year? Are we kind of seeing gains we're going to see for the full year in the first quarter, or potentially there's some additional savings to be had?
Sure. Yeah. I'll let Dave jump into some of the numbers. Just at a high level, certainly business mix impacts the level of SG&A and gross margins, as we mentioned on the call, which we do expect to increase towards the back part of this year. We are very diligent about the cost side of the business and need to be moving forward as well. There's no change there. We continue to expect to be aggressive on the cost side. I'll let Dave weigh in if there's anything specific on SG&A you want to hit.
Yeah, Pete, the only other thing I would say there is some of that was obviously the Language Solutions business coming out in the back half of 2018. So, we'll be overlapping that, I think, from a run rate perspective, somewhere in kind of the low $50 million mark, and obviously some of that depends on the seasonality and the revenue in the quarter. In that kind of low 50s per quarter makes sense for the back half of the year.
Our next question is from Michael Zhao from J.P. Morgan.
Hi, good morning. I was wondering if I.
Good morning
just get a little bit more color on the investment markets segment. I think you called on the special proxy, some higher print volumes and some revenue shifts. Can you just give us a sense of those buckets of revenues, one that shifted in and two, kind of the piece from the higher print volumes that you saw, particularly in the quarter. Just to follow up from that, just taking a step back, can you talk a little bit about the pricing environment that you're seeing in the investment markets segment?
Sure, Mike. When you look at U.S. investment markets on a year-over-year basis, there was growth of about almost $4 million. When we look at the special proxy, that work was about also $4 million. Some of the timing shifts out of Q2 into Q1 were worth a couple million dollars. From a pricing perspective, not too much different there in terms of what we've seen in overall trends. Obviously, as the funds are under fee pressure, kind of coming back to us and looking to reduce costs. I think we've talked about it in the past, some of the solutions that we can provide, with the FundSuite ARC platform , allow us to help our clients achieve that cost reduction without necessarily it being a pure price reduction to us.
Understood. Thanks. If I could just squeeze one in on the capital markets segment. I think you said, year-over-year volumes improved as the quarter went on, and I think you used the term normalized in March. Can I just ask, what's the exit rate that you saw for March year-over-year in terms of the capital markets volumes?
Yeah. March was still down slightly on a year-over-year basis. As Dan and I both talked about, the pipeline is starting to build and looks, I'd say, fairly similar to what we saw last year. Strength on the IPO side, as we noted, a little bit softer on the M&A side. From an overall Q2 perspective, like I said, kind of leaving the first quarter, March was still down slightly, but clearly momentum coming into Q2.
Okay, great. Thank you.
You're welcome.
Thank you.
Our next question is from David Ridley-Lane from Merrill Lynch.
Good morning.
Morning.
Just on the digital print investment, when would that be up and running and how quickly could that start to show up in better profitability on the print side?
David, it's Tom. We were up and running and in production in April. We took delivery at the beginning of the year, and we went into production in April. As we start to load it starts to flow through our business.
David, just to be clear, from an incremental revenue perspective, we don't expect it to have much impact. It's really more of a productivity play, being able to load assets on a more cost-effective basis. That's obviously part of our cost reduction initiatives and baked into our full-year guidance.
Got it. I just missed. Just to check on the numbers for your expectations around second quarter revenue?
Yes. Second quarter revenue in the range of $260 million-$270 million. That's, obviously, $19 million on a year-over-year basis. $19 million is decline related to Language Solutions. When you look from an organic perspective, at the high end of the range, it's essentially flat. At the midpoint, it's down, I think, almost 2%. Again, some of that is related to the softer M&A environment, as well as some of the timing shifts we saw on the investment market side.
Got it. Last one for me. Clearly the U.S. IPO market has come roaring back here. Wondering if you have become more optimistic around the capital markets environment as we've gone through the quarter.
I think certainly, as we said even on the fourth quarter call, our expectation with the volatility that we saw in Q4 and saw with the government shutdown, we expected what we experienced in terms of the lack of activity early in the quarter. There was a lot of confidence leading into 2019 on a robust IPO market. I would say our expectations have narrowed as we've moved further along. We are seeing the robust IPO market. We mentioned, we feel very good about the deals that we're getting. I think the M&A market, to the earlier comments, is a lot of things are now being announced and are being put into the pipeline. The lead time there tends to be a little bit longer, which is why we see that taking place in the back part of the year.
We feel very good about the IPO market, specific to your question.
Thank you very much.
Thank you. Okay, it appears no more questions. Operator, with that, we would thank everyone for participating, and we'll talk to you in early August. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect.