The Dolan Company's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 2.13 | About: Dolan Co (DOLNQ)

The Dolan Company (NYSE:DM)

Q2 2013 Earnings Conference Call

August 1, 2013 8:30 a.m. ET

Executives

James Dolan - President, Chairman and Chief Executive Officer

Vicki Duncomb - Vice President and Chief Financial Officer

Scott Pollei - Executive Vice President and Chief Operating Officer

Robert Evans - Director, Investor Relation

Analysts

George Sutton - Craig-Hallum Capital Group

Jason Ursaner - CJS Securities

Operator

Welcome to the Second Quarter 2013 Earnings Conference Call. My name is Shannon and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Bob Evans.

Robert Evans

Thank you, operator. Good morning, ladies and gentlemen, and welcome to The Dolan Company’s second quarter 2013 earnings call. On the call today are Jim Dolan, Chairman, Chief Executive Officer and President; Scott Pollei, Executive Vice President and Chief Operating Officer; and Vicki Duncomb, Vice President and Chief Financial Officer.

By now, you should be able to access our second quarter earnings release, which we issued today at 5 a.m. Eastern Time. If you haven’t seen our release, you can find it on the Investor Relations Section of our website at www.thedolancompany.com. We’ve also posted our slide presentation supplementing this conference call on our website. Today’s earnings release and the slide presentation contain a reconciliation of GAAP financial measures to the non-GAAP financial measures we will discuss.

Before we begin, I’d like to remind everyone of the Safe Harbor statement. During this call we will make forward-looking statements including statements about beliefs, expectations, plans, goals, projections, guidance for 2013, and circumstances we expect to affect our future operating results, including divestitures we have completed and are pursuing, and trends we see in mortgage foreclosures, efforts to mitigate foreclosures, public notice advertising and e-discovery.

These forward-looking statements are subject to risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed in or implied by these statements. Information about such risks and uncertainties is contained in our company’s filings with the SEC, in particular the risk factor and forward-looking statement sections of the company’s quarterly and annual reports.

And now I’ll turn the call over to Jim Dolan.

James Dolan

Thanks, Bob, and thanks to all of you for joining us today. The second quarter of 2013 compared pretty well for the previous year. Quarterly revenues increased by 14% while adjusted EBITDA was up by 15%. Our revenue and EBITDA growth in the quarter were driven by DiscoverReady, but they were offset in part by weakness in our public notice, advertising business and by the remaining portion of National Default Exchange NDeX, which now has us only in Michigan and Minnesota.

We are pleased that our eDiscovery business experienced a very strong quarter as we saw good growth in both its review and technology processing segments. As we previously announced after the second quarter ended, we sold our NDeX South and NDeX Indiana operations to our law firm affiliates for a total consideration of $17.5 million, with the majority of payments coming within the next three years. Although we are not happy that the state of the industry brought us to this point, we do believe that these divestitures give us more clarity regarding the future and were in our shareholders, best interests.

The future of the mortgage default processing business remains unclear. We believe it was going to be very difficult for both NDeX and or law firm affiliates to be profitable in the current environment. Our intention is to pursue the sale of NDeX operations in Michigan and Minnesota, although right now these activities are at a preliminary stage.

We are pleased with the second quarter performance of our eDiscovery company. DiscoverReady reported strong revenue this quarter which continues what we have seen in this business for the past year once we have fully integrated the ACT acquisition and took over day to day management of its sales force. There was solid growth from long-term DiscoverReady clients as well as progress in developing new client relationships.

Our higher margin technology processing business is starting to do well and in the future we expect this part of the business to be a larger portion of our overall eDiscovery revenue mix. We are also pleased with the healthy balance we are seeing between our document review and technology processing segments of the eDiscovery business.

During the second quarter, revenue from our business information division declined somewhat, mostly due to lower public notice advertising revenues. As we have discussed in past earnings calls, the mortgage default slowdown affecting NDeX, also has affected an important category of public notices. Other revenues categories in the business information division were modestly down. We continue to work on finding ways to add new revenue streams for this division while continuing to improve the cost structure wherever we can.

In today's earnings release, we are maintaining the initial 2013 revenue and adjusted EBITDA guidance that published earlier in the year. As a reminder, this guidance continues to exclude any NDeX results. For 2013, we expect both DiscoverReady and the litigation support segment to grow at double-digit rates over the prior year with positive EBITDA leverage. However, we must point out that we expect DiscoverReady's third quarter revenues to be below last year's all time record revenue quarter.

We make this comment not to dampen enthusiasm about our growth prospects for DiscoverReady, but to set proper expectations for a business that may experience lumpiness on a quarter-to-quarter basis. Given the near term trends in default related public notice advertising, we expect our business information division in 2013 to produce revenues that are, compared to last year, down high-single digits to low double-digits with negative EBITDA leverage. Our guidance excluded any effect of future M&A activity. It also is subject to assumptions which are detailed in our earnings release which now is available on our website.

Now I will turn the call over to Vicki.

Vicki Duncomb

Thank you, Jim and good morning everyone. Our second quarter financial results reflect meaningful improvement in DiscoverReady, our eDiscovery business compared to last year. As Jim stated previously, second quarter results in NDeX remain depressed and only reflect results of our Michigan and Minnesota operations, given the sale of NDeX South and NDeX Indiana subsequent to the end of the quarter. Our business information segment was down in the second quarter compared to last year but tracked to our expectations as the headwinds experienced in the public notice business during the last couple of quarters continued.

Second quarter revenue increased by 13.5% to $47.5 million, compared to the prior year, while adjusted EBITDA grew 14.6% to $8.4 million. This quarter's adjusted EBITDA results include positive operating leverage from our DiscoverReady business, offset by negative operating leverage at both NDeX and the business information division. Net loss attributable to The Dolan Company was $140.4 million, or $4.63 per diluted share. Second quarter results include a pretax loss of $89.7 million, primarily from non-cash impairment charges related to our NDeX businesses.

Additionally, we recorded $49.6 million of tax expense for the quarter, primarily related to the recording of a non-cash valuation allowance against all of our Federal and state deferred tax assets. Given the complexity of the tax laws surrounding our transactions and our current status, we have not determined the tax benefits of these transactions. However, the majority of any tax benefits derived should come in the form of a reduction of future tax payments versus a tax refund, because most of the company's previously accumulated net operating losses have been used.

Cash earnings were $2.9 million or $0.10 per diluted share. We believe cash earnings per share is a better metric to measure the profitability of the ongoing business, particularly with the non-cash charges experienced this quarter. Now let's review our different business. Litigation support revenue driven by continued strength in the eDiscovery business, reported growth of 59.9% to $25.9 million. DiscoverReady, our eDiscovery business, grew by 74.2% this quarter and saw strength from existing clients while continuing to see new client relationships mature and set the stage for future growth.

We remain excited and encouraged about the client opportunities and growth prospects with this business. At NDeX, where operations are considerably smaller, given our recent divestitures, revenue remained depressed and was down 32% to $4.9 million. This quarter results would have been on a pro forma basis, $10.8 million of revenue, and an adjusted EBITDA loss of more than $3 million from NDeX South and NDeX Indiana. This is a continuation of the challenges we have seen in the mortgages default processing industry. Revenue for the business information segment was down 9.5% to $16.6 million, as public notice advertising experienced a slowdown related to the same factors that affected NDeX. While display and classified advertising and subscription revenues experienced a very modest decline.

They company's direct operating margin declined to 57.4% from 59.7% last year. This reflects the negative operating leverage at NDeX, business information, as well as the mix of businesses at DiscoverReady. SG&A expense for the company was basically flat at $19.8 million. However, we note that this quarter's SG&A expense includes roughly $1 million of expense due to severance and professional fees associated with our restructuring efforts. During the quarter we continued to make progress in improving our balance sheet. Payments plus the tax refunds reduced our net debt to $140.6 million at the end of the second quarter as we lowered our leverage ratio to four times debt to trailing 12 months pro forma adjusted EBITDA.

This is a reduction of net debt from $162.5 million at the end of 2012. We were in compliance with all of our debt covenants at the end of the second quarter. Cash used in discontinued operations was $4.9 million and cash provided by continuing operations was $13.8 million. As we make progress in divesting our NDeX operations, we look forward to having a simpler, more clearly defined operating structure that will be focused on growth while generating earnings and cash flow that we plan to use to deleverage our balance sheet as quickly as possible.

And now, I will return the call to Jim.

James Dolan

Thanks, Vicki. We have tried to be very frank at acknowledging our challenges related to NDeX and mortgage default processing. We are dealing with those challenges very aggressively. As that comes to completion, we are encouraged that we will be able to focus much more on our DiscoverReady growth engine, given as we continue to seek new revenue streams and improved margins in our other businesses. We are very excited about our eDiscovery business and the balanced growth we are seeing in our revenue and processing segments.

We believe DiscoverReady can be a much bigger and more profitable operation then it is today. We see many avenues of growth. Now let me just say one more thing about NDeX. We are moving away from providing some services, true. We are also moving towards what we believe to be a new and better business model. As we leave the more labor intensive parts of NDeX, we are focusing on providing high value, technology services to the existing NDeX client base, as well as toe other prospective clients in the mortgage default industry.

Please recognize that this transformation although exciting to us, is in fact in its early days. Investors shouldn’t plan for any meaningful EBITDA contribution in the near-term as we map out how to best grow this business, which will emerge with a new name to be announced in the future. We will, of course, update you on our progress as this business takes shape. Our focus and all of our efforts are to build a stronger and better performing company that rewards our investors for their support.

With that, I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from George Sutton from Craig-Hallum Capital.

George Sutton - Craig-Hallum Capital Group

Jim, could you give us a little more detail on the strength in the quarter from the DiscoverReady side and explain the lumpiness in terms of what was so strong in Q2 and what slows down in Q3?

James Dolan

Well, it's hard to be very specific about the lumpiness now without getting into details we normally do not disclose. But the reference point, of course last year we had a large matter was pushed back from first half to second half, so the basis for comparison last year was quite high. We had a number of matters that were in works in the first half, all of which made for a very strong quarter. We don’t see those right now in the second half of the year but these things do come and they come sometimes unexpectedly, sometimes quickly. So given the lack of forward visibility on this kind of business, we have to be cautious in how we describe things.

George Sutton - Craig-Hallum Capital Group

Okay. Relative to the technology services that you talk about for NDeX or the NDeX market, could you just give us a sense of what has developed thus far? Is it a platform that ultimately you would be offering to service providers? And if you could give us any sense of where you are in the continuum of getting the revenues, that would be great.

Scott Pollei

George, we have got several different things that we are working on with that technology. One is taking our proprietary software and adapting it for other states and licensing it to other law firms, much as we have done in our existing spots. And then we are also taking the infrastructure, we have got two world class data centers in Detroit and in Dallas that we can leverage and provide private cloud services to our customers. So it's an expansion of those two thoughts.

James Dolan

The core of our offering is compliance services. We have tested and proven systems and services surrounding compliance and the mortgage and default spaces. And they have withstood audits very well. The clients know them, clients being servicers. And so that’s the core of the offerings. And the private cloud services and other things are important components of that but it's that compliance core to the business going forward.

George Sutton - Craig-Hallum Capital Group

Got you. Lastly for me, could you just update us on how the relationships are with the banks and the debt covenants?

Vicki Duncomb

George, this is Vicki, good morning. I guess I would assume that you saw our recently amended credit agreement to allow for the NDeX divestitures, which sold our NDeX Texas, California and Nevada, Indiana operations. And as you might know, those divestitures significantly change our business and make some of the bank covenants that we have previously had, difficult to meet. So we are in active discussions with the banks right now on a need to, or to reset the financial covenants applicable to the third quarter in the future periods. You know, I can't expand on that right now, we will update you as we get closer. But, again, I also want to remind you that we are not in danger of failing to make any payments. It's just we have to continue to reduce our debt and we are working on that.

Operator

(Operator Instructions) Our next question comes from Jason Ursaner from CJS Securities.

Jason Ursaner - CJS Securities

Just a follow-up on the eDiscovery piece. You mentioned before relatively limited visibility by quarter. I was just wondering, Jim, if you could talk a little more about both the long-term competitive position of that business. And one of the knots on the (inaudible) has been concerns for barriers to entry. But just maybe how you see the long-term visibility for that business, given its competitive position.

James Dolan

Yeah, I think with our strong management there as a base, we have several, in some cases acquired, in some cases built, a terrific integrated approach to offering the services that this sector needs. We have go the technology, we have got the hosting and processing, we have got the ability to create and adapt the technology tools where necessary, customize to client needs. We have got, we think the best review in the business. We have got strong managerial skills at low cost, so we can offer clients the best pricing. To put it all together, it's a very strong integrated offering that puts us, we think in the upper quadrant of the industry, as far as the ability to provide long-term services.

The technology component lets us in a way build a longer term, smoother relationship with the clients. So that the data that is needed is residing on our servers, which gives us advantages in doing the downstream business to close from that. There are a lot of smaller players with pieces of this. There is a relatively short list of players with these kind of integrated set of offerings that we have. We are proud of what we have got, we think it's the best in the industry.

Jason Ursaner - CJS Securities

Okay. And do you think there are still other -- I know you've talked about the verticals within it, I mean are there other pieces that you would want to still be adding to your integrated solution, or it's pretty well set at this point...?

James Dolan

You know we don’t have to acquire anything to do what we want. We may want to. There maybe things that are attractive to us, but we don’t have to. We have got the major components in place and fully, integrated nicely now. So there may come from time to time some things that we want to buy though.

Jason Ursaner - CJS Securities

Okay. And on NDeX, obviously the decision to sort of exit that business and the intention to fully exit it is implying your view on the recovery for foreclosures. I guess how do you relate that back to maybe expectations for recovery on the business information side with public notice? Is it similar expectations and just more willing to wait out the time there?

James Dolan

Well, the two are directionally the same but there is some important differences. We expect other to be a recovery in there foreclosure activity. We don’t know when that is, we have been saying that for a long time now, we still don’t know. And that’s driving us to make the NDeX changes that we are making. We are not fully exiting it. We are keeping the technology component to that, that we think has a new and interesting feature for us. So it's a mostly exit but not entirely. For business information -- public notice is a much larger, more diverse revenue stream then just foreclosure related stuff. In a normal year foreclosure activity is between 20% and 30% of the volume when it comes to public notices. There are 500 kinds of public notices after all.

So you also see some public notice flow from foreclosures coming before other activities that might have affected NDeX. When a file is in effect frozen and then the servicer decides to move it along and to finish the foreclosure process, quite often that has to be re-advertized. That’s another revenue opportunity for us. It's an early indicator of foreclosure activity. So we are very interested in keeping that business. It's our highest margin business activity. We have a lot of other things going on in the business information division, so this is not the only play we have there. It's certainly something we want though. So we have got the investment. We are patient and we think that’s going to reward us for doing that earlier than it would have rewarded just for keeping NDeX.

Jason Ursaner - CJS Securities

Okay. And just last question from me. Any update on the non-strategic assets within the business information segment? I think you talked about looking potentially to monetize some of those?

James Dolan

We have announced we are holding them as a discontinued operations, and we are trying to be very disciplined and not talk about M&A activities until we announce what has been done. So at this point we have no announcements about that.

Operator

(Operator Instructions) Our next question comes from (inaudible).

Unidentified Speaker

I understand that the complicated nature of the NDeX South transaction prevents giving firm guidance on potential tax assets. But we are wondering if you could give investors a basic framework on how to look at potential tax assets related to the NDeX South divestiture.

Vicki Duncomb

I dint quite here the whole question. Could you repeat it, please?

Unidentified Speaker

Sorry, I was just wondering if you could give investors a basic framework on how we should we looking at potential tax assets related to the NDeX South divestiture.

Vicki Duncomb

We have a net loss operating loss when we divested Texas, NDeX South. And certainly we put up a valuation allowance on it just because, to be conservative and we had some operating losses, so we put up a valuation allowance on it. But here is the ability to use those and allow as we go forward, the tax income to offset any tax cash payments we would have to make from a federal standpoint.

Unidentified Speaker

Okay. Great. So my understanding is that NDeX South was originally purchased for roughly $200 million, so a divestiture for consideration of let's say $17.5 would results in approximately $180 million of tax assets, so to shield future taxable income?

Vicki Duncomb

That’s approximately right.

Unidentified Speaker

So therefore it's fair to say that the company will not be a tax payer for at least five years as a result of the divestiture of NDeX South?

Vicki Duncomb

Again, there is a lot of things that go. I am not a tax expert on all of the things that go into it but we are anticipating that we will not be paying a large amount of taxes in the future.

Operator

(Operator Instructions)

James Dolan

Well, I think we are done this morning. Thanks everyone for your kind attention and for listening our story. We look forward to speaking with you. If any of you wants to reach out to Bob Evans, please go so. Thanks and have a nice day.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.

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