false FY DFIN 0001669811 --12-31 No Yes No Large Accelerated Filer --10-31 0.125 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 terms of the arrangements with RRD do not exceed 36 months. 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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to

Commission file number 1-37728

 

Donnelley Financial Solutions, Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

36-4829638

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

35 West Wacker Drive, Chicago, Illinois

 

60601

(Address of principal executive offices)

 

(ZIP Code)

Registrant’s telephone number, including area code—(844) 866-4337

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each
Class

 

 

 

Name of each exchange on which
registered

 

Common Stock (Par Value $0.01)

 

NYSE

 

 

Securities registered pursuant to Section 12(g) of the Act:  None

Indicated by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes      No  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    

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

 

Large accelerated filer 

 

Accelerated filer

 

Non-accelerated filer 

 

Smaller reporting company 

 

 

 

 

 

(Do not check if a smaller reporting company)

Emerging growth company

 

 

 

 

 

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 Act).    Yes      No  

The aggregate market value of the shares of common stock (based on the closing price of these shares on the NYSE) on June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, held by nonaffiliates was $773,142,550.

As of February 23, 2018, 33,844,902 shares of common stock were outstanding.

Documents Incorporated By Reference

Portions of the registrant’s proxy statement related to its annual meeting of stockholders scheduled to be held on May 24, 2018 are incorporated by reference into Part III of this Form 10-K.

 

 

 

 


 

 

DONNELLEY FINANCIAL SOLUTIONS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2017

 

TABLE OF CONTENTS

 

 

 

Form 10-K
Item No.

 

Name of Item

 

  

Page

 

Part I

 

 

 

 

  

 

 

 

 

 

Item 1.

 

Business

  

 

3

  

 

 

Item 1A.

 

Risk Factors

  

 

10

  

 

 

Item 1B.

 

Unresolved Staff Comments

  

 

20

  

 

 

Item 2.

 

Properties

  

 

20

  

 

 

Item 3.

 

Legal Proceedings

  

 

20

  

 

 

Item 4.

 

Mine Safety Disclosures

  

 

20

  

 

Part II

 

 

 

 

  

 

 

 

 

 

Item 5.

 

Market for Donnelley Financial Solutions, Inc. Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  

 

21

  

 

 

Item 6.

 

Selected Financial Data

  

 

23

  

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

 

25

  

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

  

 

45

  

 

 

Item 8.

 

Financial Statements and Supplementary Data

  

 

46

  

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  

 

46

  

 

 

Item 9A.

 

Controls and Procedures

  

 

46

  

 

 

Item 9B.

 

Other Information

  

 

48

  

 

Part III

 

 

 

 

  

 

 

 

 

 

Item 10.

 

Directors and Executive Officers of Donnelley Financial Solutions, Inc. and Corporate Governance

  

 

49

  

 

 

 

 

Executive Officers of Donnelley Financial Solutions, Inc.

  

 

49

  

 

 

Item 11.

 

Executive Compensation

  

 

49

  

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  

 

50

  

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  

 

50

  

 

 

Item 14.

 

Principal Accounting Fees and Services

  

 

50

  

 

Part IV

 

 

 

 

  

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

  

 

51

  

 

 

Item 16.

 

Form 10-K Summary

 

 

51

  

 

 

 

 

 

 

 

 

 

 

Signatures

  

 

 

 

2


 

PART I

ITEM 1.

BUSINESS

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:

 

United States. The U.S. segment is comprised of three reporting units: capital markets, investment markets, and language solutions and other. The Company services capital market and investment market clients in the U.S by delivering products and services to help create, manage and deliver financial communications to investors and regulators. The Company provides capital market and investment market clients with communication tools and services to allow them to comply with their ongoing regulatory filings. In addition, the U.S. segment provides clients with communications services to create, manage and deliver registration statements, prospectuses, proxies and other communications to regulators and investors. The U.S. segment also includes language solutions and commercial printing capabilities.

 

International. The International segment includes 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 within the United States. In addition, the International segment provides services to international investment market clients to allow them to comply with applicable U.S. Securities and Exchange Commission (“SEC”) regulations, as well as language solutions to international clients.

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, beginning October 1, 2016, the Company incurs such costs directly.

For the Company’s financial results and the presentation of certain other financial information by segment, see Note 17, Segment Information, to the Consolidated and Combined Financial Statements. For financial information by geographic area, including net sales and long-lived assets, see Note 18, Geographic Area and Products and Services Information, to the Consolidated and Combined Financial Statements.

Client Services 

The Company’s business is diversified across a range of products and services that enable it to work with companies and their advisors at different points throughout the business lifecycle, including private companies, public companies and companies that have filed for bankruptcy. The Company’s clientele is primarily focused in three areas: capital markets, investment markets, and language solutions, and the Company also provides clients with Data and Analytics services and products. The Company services clients in each of these areas with distinct, proprietary solutions tailored to meet their varying regulatory, transactional and communications needs and are able to achieve operational leverage through the use of common technology and service platforms. 

Global Capital Markets 

The Company’s global capital markets (“GCM”) clients consist mainly of companies that are subject to the filing and reporting requirements of the Securities Act of 1933, as amended (the “Securities Act”) and the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). In 2017, approximately 39% of GCM net sales were compliance in nature. The Company also supports public and private companies throughout the mergers and acquisitions transaction process and in public and private capital markets transactions with deal management solutions focused on aiding transactional efficiency from inception to completion. In 2017, approximately 49% of GCM net sales were transactional in nature and approximately 12% of GCM net sales were related to Venue data room services. The Company provides a comprehensive suite of products and services to help its GCM clients comply with disclosure obligations, create, manage and deliver accurate and timely financial communications and manage public and private transaction processes. The Company also provides GCM clients with data and analytics services focused on uncovering intelligence from financial disclosures and offering distribution of company data and public filings. 

3


 

Many of the Company’s GCM clients are companies required by the SEC to file reports pursuant to the Exchange Act, through the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. The EDGAR system requires filers to prepare and submit filings using the SEC’s specified file formats. The Company’s EDGAR filing services assist its GCM clients in preparing Exchange Act filings that are compatible with the EDGAR system, and its employees have expertise and significant experience navigating this process with companies and their advisors. Specifically, many of the Company’s GCM clients are required to file proxy statements pursuant to the Exchange Act, and the Company’s Proxy Design service allows its clients to tailor these proxies by helping them to identify and match an appropriate style and format to their unique corporate culture and proxy-related objectives. The Company serves its GCM clients from local offices in most major cities in the U.S. and international jurisdictions in which the Company has operations. The Company believes that its local teams set the standard for reliable and efficient service and convenience. 

As part of their regulatory filing requirements, the Company’s GCM clients who submit Exchange Act reports are also required to submit tagged files in the SEC-mandated eXtensible Business Reporting Language (XBRL) format. The Company provides these clients with a suite of tagging, review and validation tools to assist them with the XBRL requirements, and the Company has teams of accounting and financing professionals that assist its GCM clients with the processes of tag selection, tag review, file creation, validation and distribution, if required for their Exchange Act filings with the SEC. 

In addition to the EDGAR filing services it provides, in which it formats and manages the content of the filings on behalf of its clients, the Company also offers a cloud-based disclosure management system called ActiveDisclosure that allows its GCM clients to collaboratively create, review and distribute financial communication and regulatory compliance documents on their own systems and then file directly on the SEC’s EDGAR system and File 16 for Section 16 filings, each of which, with assistance from the Company’s experienced professionals as needed, may reduce the time of the financial close process for its clients. 

The Company provides services for GCM clients throughout the course of public and private business transactions, including those transactions that are subject to the requirements of the Securities Act. The Company assists many of its clients with certain transaction-related EDGAR filing and print services (including registration statements, prospectuses, offering circulars, proxy statements and XBRL-tagged filings), as well as with the technical aspects of the regulatory filing process. The Company has conferencing facilities in most major cities in the U.S. and the international jurisdictions in which it has operations for in-person working groups to meet to strategize and prepare documents for the transactional deal stream. The Company’s sites are outfitted to provide EDGAR filing capabilities, typesetting, meeting rooms and around-the-clock service. 

In addition, for both public and private transactions, many of the Company’s GCM clients use its line of Venue products and services to manage the transaction process and increase efficiency. The Company’s Venue Virtual Data Room product is a cloud-based service that allows companies to securely organize, manage, distribute and track corporate governance, financing, legal and other documents in an online workspace accessible to internal and outside advisors alike. The Company’s GCM clients use Venue Virtual Data Rooms for capital markets transactions, mergers and acquisition transactions and other transactions to facilitate their document management and due diligence processes. 

Venue Deal Marketing is a service provided through Peloton Documents, a company in which the Company has made a strategic investment. The Peloton solution creates interactive transaction related documents that enable companies, investors and advisors to communicate a company’s value and market and manage large, complex deals directly from their data room. Peloton’s technology leverages video and other rich media content as the vehicle to illustrate the value of a business by enabling the user to tell a more dynamic company story to better gauge interest from potential buyers and investors. Users include some of the world’s largest investment banks and private equity firms. 

Venue Contract Analytics, part of the Venue Deal Solutions Suite, is a service provided through eBrevia, a company in which the Company has made a strategic investment.  The eBrevia technology provides leading enterprise contract review and analysis solutions, leveraging machine learning to produce faster and more accurate results. eBrevia's software, which extracts and summarizes key legal provisions and other information, can be used in due diligence, contract management, lease abstraction, and document drafting. 

SOXHUB, part of the ActiveDisclosure compliance solution, is a service provided through AuditBoard, a company in which the Company has made a strategic investment. AuditBoard is a SaaS technology company that provides a full suite of easy-to-use audit management and compliance solutions for SOX, operational audits, IT compliance, ERM and workflow management.  With AuditBoard, enterprises can collaborate, manage, analyze and report on critical internal controls data in real time. Users span from industry-leading pre-IPO to Fortune 50 companies looking to streamline their accounting and audit functions.

4


 

Global Investment Markets 

The Company provides products and services to clients operating in global investment markets (“GIM”) within the United States and internationally, including United States based mutual funds, hedge and alternative investment funds, insurance companies and overseas investment structures for collective investments (similar to mutual funds in the United States). The Company also provides products to third party service providers and custodians who support investment managers, and it sells products and distribution services to the broker networks and financial advisors that distribute and sell investment products. The Company services the top variable annuity and variable life providers as well. The firms use the Company’s software products to manage data and content for data driven regulatory reporting as well as the creation of financial reports, prospectuses, fact sheets and other marketing and disclosure documents. The Company also provides software products to manage the distribution of the data and content in support of marketing, sales, and enrollment processes for the purchase of investment products. The Company supports healthcare clients in content management and the creation of pre- and post-enrollment materials. The Company processes orders and distributes customized, digitized communication for its healthcare clients, their brokers and their plan sponsors.

In 2017, approximately 95% of GIM net sales, excluding postage and freight, were compliance in nature, while the remaining 5% of GIM net sales were transactional in nature In addition, approximately 53% of the Company’s 2017 GIM net sales, excluding postage and freight, were derived from clients in the mutual funds industry, while the remaining 47% of net sales were derived from clients in the healthcare and insurance industries. The Company’s teams currently support clients in the United States, Canada, Ireland, the United Kingdom, France, Luxembourg, India and Australia. 

The Company offers its GIM clients a comprehensive set of products and services, including the FundSuiteArc software platform. FundSuiteArc is a suite of online content management products, which enable the Company’s GIM clients to store and manage information in a self-service, central repository so that compliance and regulatory documents can be easily edited, assembled, accessed, translated, rendered, and submitted to regulators. 

In the United States, mutual funds, variable annuity products, and qualifying institutional hedge funds are required by the SEC to file registration forms and subsequent ongoing disclosures as well as XBRL-formatted filings pursuant to the 1940 Act, through the SEC’s EDGAR system. Using its filing capabilities, the Company works with many of its GIM clients to prepare and submit these 1940 Act and XBRL filings using the SEC’s specified file formats. 

Changes in how investors consume information have led to new ways for investors to receive disclosure documents. GIM offers various technology and electronic delivery products and services to make the distribution of documents and content more efficient. Through an investment in, and an agreement with Mediant, the Company provides a suite of software to brokers and financial advisors which enable them to monitor and view shareholder communications.  The Company also supports the distribution, tabulation, and solicitation of shareholders for corporate elections and mutual fund proxy events.

Language Solutions 

The Company supports domestic and international businesses in a variety of industries by helping them adapt their business content into different languages for specific countries, markets and regions through a complete suite of language products and services. The Company’s suite of services includes translation, editing, interpreting, proof-reading and multilingual typesetting, plus specialized content services such as transcreation (cultural adaptation of marketing materials), copywriting, linguistic validation by subject matter experts (specifically in the life sciences sector), transcription, voice-over, subtitling, and localization (website software adaptation for a specific market). The Company also provides application testing and quality assurance, which enable consistent performance of web, desktop and mobile applications, as well as cultural consulting services, helping corporations with their cross-cultural communications. The Company engages with independent contractors through a network of over 6,000 accredited, in-country linguists to support any language translation. Linguists are recruited through a rigorous testing process carried out by the Company’s vendor management. Through previous professional experience, linguists specialize in one or more verticals and sub-verticals, which enable the Company’s clients to communicate with confidence to their markets using linguists who are experts in the field. 

The Company’s language solutions services are supported by its innovative language technology, including a market leading proprietary Translation Management System (MultiTrans) with terminology management and translation memory features. This state-of-the-art system stores terminology preferences and reduces costs by using previously-translated content. In addition, the Company offers a website translation service which is a cloud-based platform that enables dynamic website translation. The Company also continually drives innovation with new technologies, such as voice recognition to gain efficiencies in audio-to-text solutions, and machine translation, combining this with existing services such as machine translation post-editing and a full suite of other add-on services. 

 

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The Company generally provides its suite of services and technology to clients through project-by-project or preferred vendor arrangements. Donnelley Language Solutions clients are serviced from one of the Company’s global locations, in the Americas, the Asia Pacific region, or Europe, the Middle East and Africa. The Company provides its language solutions offerings to clients operating in a variety of industries, including the financial, corporate, life sciences and legal industries, among others. In 2017 the Company provided services to companies in 73 different countries.

Data and Analytics 

The Company also helps professionals uncover intelligence from financial disclosures, offering distribution of company data and public filings for equities, mutual funds and other publicly traded assets through Application Program Interfaces, or APIs, online subscriptions and data licenses. The Company extracts critical company data in real time, verifies its accuracy, converts it to value-added formats like XML, JSON and XBRL, securely stores the information and then provides clients access to the data through various delivery methods. 

The Company is able to leverage proprietary technology to create robust, timely and accurate data sets, distributing high quality, interactive financial data and services to the investment community. With deep experience and knowledge, the Company is advancing how financial data is consumed, delivered and analyzed, helping to transform data points into constructive, valuable information. 

In addition to access to data sets, the Company provides subscription-based proprietary desktop and web tools for data analysis. EDGARPro enables investors, analysts, lawyers, auditors and corporate executives to access detailed company information, as-reported and standardized financial data, SEC filings, stock quotes and news. I-Metrix, a Microsoft Excel plugin, provides quick and accurate XBRL-tagged financial statement data via an easy-to-use web interface for data downloads, enabling simple or complex modeling with the goal of providing better, faster and smarter financial analysis and company research. The Company’s additional offerings include solutions for E-Prospectus, Investor Relations websites and XBRL data set creation and validation for use outside of SEC filings. 

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

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 no longer qualified as a related party of the Company.

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 4, 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”) from the Company. The Company received approximately $18.8 million in net proceeds from the sale of the Option Shares, after deducting estimated underwriting discounts and commissions. 

 

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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.

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. While the Company maintains 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.  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 AuditBoard (formerly known as Soxhub), Mediant, Peloton and eBrevia that support the Company’s position as a technology service leader in the industry.  

The Company’s competitors for SEC filing services for public company compliance 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.

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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.

Customers

For each of the years ended December 31, 2017, 2016 and 2015, no customer accounted for 10% or more of the Company’s consolidated and combined net sales.

Technology

The Company invests resources in developing software to improve its services. The Company invests in its core composition systems and client facing solutions and has also adopted market-leading third party systems which have improved the efficiency of its sales and operations processes.

Environmental Compliance

It is the Company’s policy to conduct its global operations in accordance with all applicable laws, regulations and other requirements. It is not possible to quantify with certainty the potential impact of actions regarding environmental matters, particularly remediation and other compliance efforts that the Company may undertake in the future. However, in the opinion of management, compliance with the present environmental protection laws, before taking into account estimated recoveries from third parties, will not have a material adverse effect on the Company’s consolidated and combined annual results of operations, financial position or cash flows.

Employees

As of December 31, 2017, the Company had approximately 3,400 employees.

Available Information

The Company maintains a website at www.dfsco.com where the Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports, as well as other SEC filings, are available without charge, as soon as reasonably practicable following the time they are filed with, or furnished to, the SEC. The Principles of Corporate Governance of the Company’s Board of Directors, the charters of the Audit, Compensation, Corporate Responsibility & Governance Committees of the Board of Directors and the Company’s Principles of Ethical Business Conduct are also available on the Investor Relations portion of the Company’s website, and will be provided, free of charge, to any shareholder who requests a copy. References to the Company’s website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of or incorporated by reference in this document.

Special Note Regarding Forward-Looking Statements

The Company has made forward-looking statements in this Annual Report on Form 10-K 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. These forward-looking statements are subject to a number of important factors, including those factors discussed in detail in “Item 1A: Risk Factors” and elsewhere in this Annual Report on Form 10-K, 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:

 

the volatility of the global economy and financial markets, and its impact on transactional volume;

 

failure to offer high quality customer support and services;

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the retention of existing, and continued attraction of additional clients and key employees;

 

the growth of new technologies with which we may be able to adequately compete;

 

our inability to maintain client referrals;

 

vulnerability to adverse events as a result of becoming a stand-alone company following the Separation from RRD, including the inability to obtain as favorable of terms from third-party vendors;

 

the competitive market for our products and industry fragmentation affecting our prices;

 

the ability to gain client acceptance of our new products and technologies;

 

delay in market acceptance of our products and services due to undetected errors or failures found in our products and services;

 

failure to maintain the confidentiality, integrity and availability of our systems, software and solutions;

 

failure to properly use and protect client and employee information and data;

 

the effect of a material breach of security or other performance issues of any of our or our vendors’ systems;

 

factors that affect client demand, including changes in economic conditions, national or international regulations and clients’ budgetary constraints;

 

our ability to access debt and the capital markets due to adverse credit market conditions;

 

the effect of increasing costs of providing healthcare and other benefits to our employees;

 

the impact of the U.S. Tax Cuts and Jobs Act (“Tax Act”);

 

changes in the availability or costs of key materials (such as ink and paper) or in prices received for the sale of by-products;

 

failure to protect our proprietary technology;

 

failure to successfully integrate acquired businesses into our business;

 

availability to maintain our brands and reputation;

 

the retention of existing, and continued attraction of, key employees, including management;

 

the effects of operating in international markets, including fluctuations in currency exchange rates;

 

the effect of economic and political conditions on a regional, national or international basis;

 

lack of market for our common stock;

 

lack of history as an operating company and costs associated with being an independent company;

 

failure to achieve certain intended benefits of the Separation; and

 

failure of RRD or LSC to satisfy their respective obligations under transition services agreements or other agreements entered into in connection with the Separation.

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 Annual Report on Form 10-K 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 Annual Report on Form 10-K to reflect any new events or any change in conditions or circumstances.

 

 

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ITEM 1A.

RISK FACTORS

 

The Company’s consolidated and combined results of operations, financial position and cash flows can be adversely affected by various risks. These risks include the principal factors listed below and the other matters set forth in the Annual Report on Form 10-K. You should carefully consider all of these risks.

A significant part of our business is derived from the use of our products and services in connection with financial and strategic business transactions. Economic trends that affect the volume of these transactions may negatively impact the demand for our products and services.

 

A significant portion of our net sales depends on the purchase of our products and use of our services by parties involved in GCM compliance and transactions. As a result, our business is largely dependent on the global market for IPOs, secondary offerings, mergers and acquisitions, public and private debt offerings, leveraged buyouts, spinouts, bankruptcy and claims processing and other transactions. These transactions are often tied to economic conditions and dependent upon the performance of the overall economy, and the resulting volume of these types of transactions drives demand for our products and services. Downturns in the financial markets, global economy or in the economies of the geographies in which we do business and reduced equity valuations all create risks that could negatively impact our business. For example, in the past, economic volatility has led to a decline in the financial condition of a number of our clients and led to the postponement of their capital markets transactions. To the extent that there is continued volatility, we may face increasing volume pressure. Furthermore, our offerings for GIM clients can be affected by fluctuations in the inflow and outflow of money into investment management funds which determines the number of new funds that are opened, as well as, closed. As a result, we are not able to predict the impact any potential worsening of macroeconomic conditions could have on our results of operations. The level of activity in the financial communications services industry, including the financial transactions and related compliance needs our products and services are used to support, is sensitive to many factors beyond our control, including interest rates, regulatory policies, general economic conditions, our clients’ competitive environments, business trends, terrorism and political change, such as the impacts from the 2016 United Kingdom referendum to withdraw from the European Union. In addition, a weak economy could hinder our ability to collect amounts owed by clients. Failure of our clients to pay the amounts owed to us, or to pay such amounts in a timely manner, may increase our exposure to credit risks and result in bad debt write-offs. Unfavorable conditions or changes in any of these factors could negatively impact our results of operations, financial position and cash flow.

The quality of our customer support and services offerings is important to our clients, and if we fail to offer high quality customer support and services, clients may not use our solutions and our net sales may decline.

 

A high level of customer support is critical for the successful marketing and sale of our solutions. If we are unable to provide a level of customer support and service to meet or exceed the expectations of our clients, we could experience a loss of clients and market share, a failure to attract new clients, including in new geographic regions and increased service and support costs and a diversion of resources. Any of these results could negatively impact our results of operations, financial position and cash flow.

A substantial part of our business depends on clients continuing their use of our products and services. Any decline in our client retention would harm our future operating results.

 

We do not have long term contracts with most of our GCM and GIM clients, and therefore rely on their continued use of our products and services, particularly for compliance related services. As a result, client retention, particularly during periods of declining transactional volume, is an important part of our strategic business plan. There can be no assurance that our clients will continue to use our products and services to meet their ongoing needs, particularly in the face of competitors’ products and services offerings. Our client retention rates may decline due to a variety of factors, including:

 

our inability to demonstrate to our clients the value of our solutions;

 

the price, performance and functionality of our solutions;

 

the availability, price, performance and functionality of competing products and services;

 

our clients’ ceasing to use or anticipating a declining need for our services in their operations;

 

consolidation in our client base;

 

the effects of economic downturns and global economic conditions; or

 

reductions in our clients’ spending levels.

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If our retention rates are lower than anticipated or decline for any reason, our net sales may decrease and our profitability may be harmed, which could negatively impact our results of operations, financial position and cash flow.

Our business may be adversely affected by new technologies enabling clients to produce and file documents on their own.

 

The Company’s business may be adversely affected as clients seek out opportunities to produce and file regulatory documentation on their own and begin to implement technologies that assist them in this process. For example, clients and their financial advisors have increasingly relied on web-based services which allow clients to autonomously file and distribute reports required pursuant to the Exchange Act, prospectuses and other materials as a replacement for using our EDGAR filing services. If technologies are further developed to provide our clients with the ability to autonomously produce and file documents to meet their regulatory obligations, and we do not develop products or provide services to compete with such new technologies, our business may be adversely affected by those clients who choose alternative solutions, including self-serving or filing themselves.

Our performance and growth depend on our ability to generate client referrals and to develop referenceable client relationships that will enhance our sales and marketing efforts.

 

We depend on users of our solutions to generate client referrals for our services. We depend in part on the financial institutions, law firms and other third parties who use our products and services to recommend our solutions to their client base, which allows us to reach a larger client base than we can reach through our direct sales and internal marketing efforts. For instance, a portion of our net sales from GCM clients is derived from referrals by investment banks, financial advisors and law firms that have utilized our services in connection with prior transactions. These referrals are an important source of new clients for our services.

A decline in the number of referrals we receive could require us to devote substantially more resources to the sales and marketing of our services, which would increase our costs, potentially lead to a decline in our net sales, slow our growth and negatively impact our results of operations, financial position and cash flow.

The spin-off from RRD could result in significant liability to Donnelley Financial.

 

The spin-off was intended to qualify for tax-free treatment to RRD and its stockholders under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the Code). Completion of the spin-off was conditioned upon, among other things, the receipt of a private letter ruling from the Internal Revenue Service (“IRS”) regarding certain issues relating to the tax-free treatment of the spin-off. Although the IRS private letter ruling is generally binding on the IRS, the continuing validity of such ruling is subject to the accuracy of factual representations and assumptions made in the ruling.   Completion of the spin-off was also conditioned upon RRD’s receipt of a tax opinion from Sullivan & Cromwell LLP regarding certain aspects of the spin-off not covered by the IRS private letter ruling. The opinion was based upon various factual representations and assumptions, as well as certain undertakings made by RRD, Donnelley Financial and LSC. If any of the factual representations or assumptions in the IRS private letter ruling or tax opinion are untrue or incomplete in any material respect, an undertaking is not complied with, or the facts upon which the IRS private letter ruling or tax opinion are based are materially different from the actual facts relating to the spin-off, the opinion or IRS private letter ruling may not be valid. Moreover, opinions of a tax advisor are not binding on the IRS. As a result, the conclusions expressed in the opinion of a tax advisor could be successfully challenged by the IRS.

 

If the Separation is determined to be taxable, RRD and its stockholders could incur significant tax liabilities, and under the tax matters agreement and the letter agreement, Donnelley Financial may be required to indemnify RRD for any liabilities incurred by RRD if the liabilities are caused by any action or inaction undertaken by Donnelley Financial following the spin-off.  For additional detail, refer to Tax Disaffiliation Agreement (Exhibit 2.4 to this Annual Report on Form 10-K).

 

The tax rules applicable to the Separation may restrict us from engaging in certain corporate transactions or from raising equity capital beyond certain thresholds for a period of time after the separation.

 

To preserve the tax-free treatment of the Separation from RRD under the Tax Disaffiliation Agreement, for the two-year period following the Separation, we are subject to restrictions with respect to:

 

 

taking any action that would result in our ceasing to be engaged in the active conduct of our business, with the result that we are not engaged in the active conduct of a trade or business within the meaning of certain provisions of the Code;

 

redeeming or otherwise repurchasing any of our outstanding stock, other than through certain stock purchases of widely held stock on the open market;

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amending our Certificate of Incorporation (or other organizational documents) that would affect the relative voting rights of separate classes of our capital stock or would convert one class of our capital stock into another class of our capital stock;

 

liquidating or partially liquidating;

 

merging with any other corporation (other than in a transaction that does not affect the relative shareholding of our shareholders), selling or otherwise disposing of (other than in the ordinary course of business) our assets, or taking any other action or actions if such merger, sale, other disposition or other action or actions in the aggregate would have the effect that one or more persons acquire (or have the right to acquire), directly or indirectly, as part of a plan or series of related transactions, assets representing one-half or more our asset value;

 

taking any other action or actions that in the aggregate would have the effect that one or more persons acquire (or have the right to acquire), directly or indirectly, as part of a plan or series of related transactions, capital stock of ours possessing (i) at least 50% of the total combined voting power of all classes of stock or equity interests of ours entitled to vote, or (ii) at least 50% of the total value of shares of all classes of stock or of the total value of all equity interests of ours, other than an acquisition of our shares as part of the Separation solely by reason of holding RRD common stock (but not including such an acquisition if such RRD common stock, before such acquisition, was itself acquired as part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, shares of our stock meeting the voting and value threshold tests listed previously in this bullet); and

 

taking any action that (or failing to take any action the omission of which) would be inconsistent with the Separation qualifying as, or that would preclude the Separation from qualifying as, a transaction that is generally tax-free to RRD and the holders of RRD common stock for U.S. federal income tax purposes.

 

These restrictions may limit our ability during such period to pursue strategic transactions of a certain magnitude that involve the issuance or acquisition of our stock or engage in new businesses or other transactions that might increase the value of our business. These restrictions may also limit our ability to raise significant amounts of cash through the issuance of stock, especially if our stock price were to suffer substantial declines, or through the sale of certain of our assets. For more information, refer to Tax Disaffiliation Agreement (Exhibit 2.4 to this Annual Report on Form 10-K).

 

Donnelley Financial’s historical financial information is not necessarily representative of the results that it would have achieved as a separate, publicly traded company and may not be a reliable indicator of its future results, particularly in light of ongoing costs of operating as a public company.

 

The historical information about Donnelley Financial prior to October 1, 2016 included in this Annual Report on Form 10-K refers to Donnelley Financial’s business as operated by and integrated with RRD. Donnelley Financial’s historical financial information for such periods was derived from the consolidated financial statements and accounting records of RRD. Accordingly, such historical financial information does not necessarily reflect the combined statements of income, balance sheets and cash flows that Donnelley Financial would have achieved as a separate, publicly traded company during the periods presented or those that Donnelley Financial will achieve in the future primarily as a result of the following factors:

 

 

Prior to the Separation, Donnelley Financial’s business was operated by RRD as part of its broader corporate organization, rather than as an independent company. RRD or one of its affiliates performed various corporate functions for Donnelley Financial, such as tax, treasury, finance, audit, risk management, legal, information technology, human resources, stockholder relations, compliance, shared services, insurance, employee benefits and compensation. After the Separation, RRD continued to provide some of these functions to Donnelley Financial, as described in Transition Services Agreement (Exhibit 2.2 to this Annual Report on Form 10-K). While Donnelley Financial has now taken over many of these services internally, Donnelley Financial’s historical financial results reflect allocations of corporate expenses from RRD for such functions. These allocations may not be indicative of the actual expenses Donnelley Financial would have incurred had it operated as an independent, publicly traded company in the periods presented. Donnelley Financial had made, and will continue to make, significant investments to replicate or outsource from other providers certain facilities, systems, infrastructure, and personnel to which Donnelley Financial no longer has access as a result of the Separation. These initiatives to develop Donnelley Financial’s independent ability to operate without access to RRD’s existing operational and administrative infrastructure have been, and will continue to be, costly to implement. Donnelley Financial may not be able to operate its business efficiently or at comparable costs, and its profitability may decline.

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Prior to the Separation, Donnelley Financials business was integrated with the other businesses of RRD. Donnelley Financial was able to utilize RRD’s size and purchasing power in procuring various goods and services and shared economies of scope and scale in costs, employees, vendor relationships and customer relationships. Although Donnelley Financial has entered into transition agreements with RRD, these arrangements may not fully capture the benefits Donnelley Financial enjoyed as a result of being integrated with RRD and may result in Donnelley Financial paying higher charges than in the past for these services. As a separate, independent company, Donnelley Financial may be unable to obtain goods and services at the prices and terms obtained prior to the Separation, which could decrease Donnelley Financial’s overall profitability. This could have a material adverse effect on Donnelley Financial’s consolidated and combined statements of income, balance sheets and cash flows for periods after the Separation.

 

Generally, prior to the Separation, Donnelley Financial’s working capital requirements and capital for its general corporate purposes, including acquisitions, R&D and capital expenditures, were satisfied as part of the corporate-wide cash management policies of RRD. Currently, following the Separation, the cost of capital for Donnelley Financial’s business may be higher than RRD’s cost of capital prior to the distribution.

Other significant changes may occur in Donnelley Financial’s cost structure, management, financing and business operations as a result of operating as a company separate from RRD. For additional information about the past financial performance of Donnelley Financial’s business and the basis of presentation of the historical consolidated and combined financial statements of Donnelley Financial’s business, refer to the discussion in Note 1, Overview and Basis of Presentation, to the consolidated and combined Financial Statements of this Annual Report on Form 10-K.

We may be unable to achieve some or all of the benefits that we expect to achieve from the Separation.

 

We believe that the Separation from RRD has allowed, and will continue to allow, among other benefits, us to focus on our distinct strategic priorities; afford us direct access to the capital markets and facilitate our ability to capitalize on growth opportunities and effect future acquisitions utilizing our common stock; facilitate incentive compensation arrangements for our employees more directly tied to the performance of our business; and enable us to concentrate our financial resources solely on our own operations. However, we may be unable to achieve some or all of these benefits. For example, in order to prepare ourselves for the Separation, we undertook a series of strategic, structural and process realignment and restructuring actions within our operations. These actions may not provide the benefits we currently expect, and could lead to disruption of our operations, loss of, or inability to recruit, key personnel needed to operate and grow our businesses after the Separation, weakening of our internal standards, controls or procedures and impairment of key client relationships. If we fail to achieve some or all of the benefits that we expect to achieve as an independent company, or do not achieve them in the time we expect, our business and consolidated and combined statements of income, balance sheets and cash flows could be materially and adversely affected.

 

RRD or LSC may not satisfy their respective obligations under the Transition Services Agreements that were entered into as part of the Separation, or we may not have necessary systems and services in place when the transition services terms expire.

 

In connection with the separation, we entered into Transition Services Agreements with both RRD and LSC. Refer to Exhibits 2.2 and 2.3 to this Annual Report on Form 10-K, both titled Transition Services Agreement, related to the agreements with RRD and LSC, respectively. These Transition Services Agreements provide for the performance of services by each company for the benefit of the other for a period of time after the separation. We rely on RRD and LSC to satisfy their respective performance and payment obligations under these Transition Services Agreements. If RRD or LSC is unable to satisfy its respective obligations under these Transition Services Agreements, we could incur operational difficulties. The agreements relating to the separation provide for indemnification in certain circumstances. There can be no guarantee that RRD or LSC, as the case may be, will satisfy any obligations owed to us under such agreements, including any indemnification obligations.

 

Further, if we do not have our own systems and services in place, or if we do not have agreements in place with other providers of these services when the term of a particular transition service terminates, we may not be able to operate our business effectively, which could negatively impact our consolidated and combined statements of income, balance sheets and cash flows. We are in the process of creating our own, or engaging third parties to provide, systems and services to replace many of the systems and services RRD and LSC have provided us since the Separation. We may not be successful in effectively or efficiently implementing the remaining systems and services or in transitioning data from RRD’s or LSC’s systems to our systems, which could disrupt our business and have a negative impact on our consolidated and combined statements of income, balance sheets and cash flows. These systems and services may also be more expensive or less efficient than the systems and services RRD and LSC have been providing during the transition period since the Separation.

 

13


 

We have incurred substantial indebtedness and the degree to which we are currently leveraged may materially and adversely affect our business and consolidated and combined statements of income, balance sheets and cash flows.

 

As of December 31, 2017, we had $458.3 million of indebtedness outstanding. Our ability to make payments on and to refinance our indebtedness, as well as any future debt that we may incur, will depend on our ability to generate cash in the future from operations, financings or asset sales. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We may not generate sufficient funds to service our debt and meet our business needs, such as funding working capital or the expansion of our operations. If we are not able to repay or refinance our debt as it becomes due, we may be forced to take disadvantageous actions, including facility closure, staff reductions, reducing financing in the future for working capital, capital expenditures and general corporate purposes, selling assets or dedicating an unsustainable level of our cash flow from operations to the payment of principal and interest on our indebtedness, and restricting future capital return to stockholders. In addition, our ability to withstand competitive pressures and to react to changes in the print and related services industry could be impaired. The lenders who hold our debt could also accelerate amounts due in the event that we default, which could potentially trigger a default or acceleration of the maturity of our other debt.

 

In addition, our leverage could put us at a competitive disadvantage compared to our competitors who may be less leveraged. These competitors could have greater financial flexibility to pursue strategic acquisitions and secure additional financing for their operations. Our leverage could also impede our ability to withstand downturns in our industry or the economy in general.

 

The agreements and instruments that govern our debt impose restrictions that may limit our operating and financial flexibility.

 

The Credit Agreement (as defined below) that governs our Credit Facilities (as defined below) and the indenture that governs the Notes (as defined below) contain a number of significant restrictions and covenants that limit our ability to:

 

 

incur additional debt;

 

pay dividends, make other distributions or repurchase or redeem our capital stock;

 

prepay, redeem or repurchase certain debt;

 

make loans and investments;

 

sell, transfer or otherwise dispose of assets;

 

incur or permit to exist certain liens; enter into certain types of transactions with affiliates;

 

enter into agreements restricting our subsidiaries’ ability to pay dividends; and

 

consolidate, merge or sell all or substantially all of our assets.

 

These covenants can have the effect of limiting our flexibility in planning for or reacting to changes in our business and the markets in which we compete. In addition, the Credit Agreement that governs our Credit Facilities requires us to comply with certain financial maintenance covenants. Operating results below current levels or other adverse factors, including a significant increase in interest rates, could result in our being unable to comply with the financial covenants contained in our Term Loan Facility and indenture. If we violate covenants under our Credit Facilities and indenture and are unable to obtain a waiver from our lenders, our debt under our Credit Facilities and indenture would be in default and could be accelerated by our lenders. Because of cross-default provisions in the agreements and instruments governing our debt, a default under one agreement or instrument could result in a default under, and the acceleration of, our other debt.

 

If our debt is accelerated, we may not be able to repay our debt or borrow sufficient funds to refinance it. Even if we are able to obtain new financing, it may not be on commercially reasonable terms, on terms that are acceptable to us, or at all. If our debt is in default for any reason, our business and consolidated and combined statements of income, balance sheets and cash flows could be materially and adversely affected. In addition, complying with these covenants may also cause us to take actions that are not favorable to holders of the Notes and may make it more difficult for us to successfully execute our business strategy and compete against companies that are not subject to such restrictions.

 

14


 

Despite our substantial indebtedness, we may be able to incur significantly more debt.

Despite our substantial amount of indebtedness, we may be able to incur significant additional debt, including secured debt, in the future. Although the indenture governing our Notes and the Credit Agreement governing the Credit Facilities restrict the incurrence of additional debt, these restrictions are subject to a number of qualifications and exceptions. Also, these restrictions do not prevent us from incurring obligations that do not constitute indebtedness. In addition, as of December 31, 2017, we had $300.0 million available for additional borrowing under our Revolving Facility (as defined in Note 12, Debt). The more indebtedness we incur, the further exposed we become to the risks associated with substantial leverage described above.

 

 

The highly competitive market for our products and services and industry fragmentation may continue to create adverse price pressures.

 

The financial communications services industry is highly competitive with relatively low barriers to entry, and the industry remains highly fragmented in North America and internationally. Management expects that competition will increase from existing competitors, as well as new and emerging entrants. Additionally, as we expand our product and service offerings, we may face competition from new and existing competitors. As a result, competition may lead to additional pricing pressure on our products and services, which could negatively impact our results of operations, financial position and cash flow.

A failure to adapt to technological changes to address the changing demands of clients may adversely impact our business, and if we fail to successfully develop, introduce or integrate new services or enhancements to our products and services platforms, systems or applications, Donnelley Financial’s reputation, net sales and operating income may suffer.

 

Our ability to attract new clients and increase sales to existing clients will depend in large part on our ability to enhance and improve our existing products and services platforms, including our application solutions, and to introduce new functionality either by acquisition or internal development. Our operating results would suffer if our innovations are not responsive to the needs of our clients, are not appropriately timed with market opportunities or are not brought to market effectively. In addition, it is possible that our assumptions about the features that we believe will drive purchasing decisions for our potential clients or renewal decisions for our existing clients could be incorrect. In the past, we have experienced delays in the planned release dates of new products and services and upgrades to such products and services. There can be no assurance that new products or services, or upgrades to our products or services, will be released on schedule or that, when released, they will not contain defects as a result of poor planning, execution or other factors during the product development lifecycle. If any of these situations were to arise, we could suffer adverse publicity, damage to our reputation, loss of net sales, delay in market acceptance or claims by clients brought against us. Moreover, upgrades and enhancements to our platforms may require substantial investment and there can be no assurance that our investments will help us achieve or sustain a durable competitive advantage in our products and services offerings. If clients do not widely adopt our solutions or new innovations to our solutions, we may not be able to justify the investments we have made. If we are unable to develop, license or acquire new solutions or enhancements to existing services on a timely and cost-effective basis, or if our new or enhanced solutions do not achieve market acceptance, our business, results of operations and financial condition will be materially negatively impacted.

Undetected errors or failures found in our products and services may result in loss of or delay in market acceptance of our products and services that could seriously harm our business.

 

Our products and services may contain undetected errors or scalability limitations at any point in their lives, but particularly when first introduced or as new versions are released. We frequently release new versions of our products and different aspects of our platform are in various stages of development. Despite testing by us and by current and potential clients, errors may not be found in new products and services until after commencement of commercial availability or use, resulting in a loss of or a delay in market acceptance, damage to our reputation, client dissatisfaction and reductions in net sales and margins, any of which could negatively impact our business.

Changes in the rules and regulations to which clients or potential clients are subject may impact demand for our products and services.

 

Many of our clients are subject to rules and regulations requiring certain printed or electronic communications governing the form, content and delivery methods of such communications. Changes in these regulations may impact clients’ business practices and could reduce demand for our products and services. Changes in such regulations could eliminate the need for certain types of communications altogether or such changes may impact the quantity or format of communications.

15


 

Our failure to maintain the confidentiality, integrity and availability of our systems, software and solutions could seriously damage our reputation and affect our ability to retain clients and attract new business.

 

Maintaining the confidentiality, integrity and availability of our systems, software and solutions is an issue of critical importance for us and for our clients and users who rely on our systems to prepare regulatory filings and store and exchange large volumes of information, much of which is proprietary, confidential and may constitute material nonpublic information for our clients. Inadvertent disclosure of the information maintained on our systems (or on the systems of the vendors on which we rely) due to human error, breach of our systems through hacking or cybercrime or a leak of confidential information due to employee misconduct, could seriously damage our reputation and could cause significant reputational harm for our clients. Techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and generally are not recognized until launched against a target. Like all software solutions, our software may be vulnerable to these types of attacks. An attack of this type could disrupt the proper functioning of our software solutions, cause errors in the output of our clients’ work, allow unauthorized access to sensitive, proprietary or confidential information of ours or our clients and other undesirable or destructive outcomes. Furthermore, our systems allow us to share information that may be confidential in nature to our clients across our offices worldwide. This design allows us to increase global reach for our clients and increase our responsiveness to client demands, but also increases the risk of a security breach or a leak of such information because it allows additional points of access to information by increasing the number of employees and facilities working on certain jobs. In addition, our systems leverage third party outsourcing arrangements, which expedites our responsiveness but exposes information to additional access points. If an actual or perceived information leak or breach of our security were to occur, our reputation could suffer, clients could stop using our products and services and we could face lawsuits and potential liability, any of which could cause our financial performance to be negatively impacted. Though we maintain professional liability insurance that includes coverage if a cybersecurity incident were to occur, there can be no assurance that insurance coverage will be available, responsive, or that available coverage will be sufficient to cover losses and claims related to any cybersecurity incidents we may experience.

A number of core processes, such as software development, sales and marketing, client service and financial transactions, rely on our IT, infrastructure and applications. Defects or malfunctions in our IT infrastructure and applications could cause our products and services offerings not to perform as our clients expect, which could harm our reputation and business. In addition, malicious software, sabotage and other cybersecurity breaches of the types described above could cause an outage of our infrastructure, which could lead to a substantial denial of service and ultimately downtimes, recovery costs and client claims, any of which could negatively impact our results of operations, financial position and cash flow.

Some of our systems and services are developed by third parties or supported by third party hardware and software and our business and reputation could suffer if these third party systems and services fail to perform properly or are no longer available to us.

Some of our systems and services are developed by third parties or rely on hardware purchased or leased and software licensed from third parties. These systems and services, or the hardware and software required to run our existing systems and services, may not continue to be available on commercially reasonable terms or at all. Any loss of the right to use any of this hardware or software could result in delays in the provisioning of our services, which could negatively affect our business until equivalent technology is either developed by us or, if available, is identified, obtained and integrated. In addition, it is possible that our hardware vendors or the licensors of third party software could increase the prices they charge, which could have an adverse impact on our business, operating results and financial condition. Further, changing hardware vendors or software licensors could detract from management’s ability to focus on the ongoing operations of our business or could cause delays in the operations of our business.

Additionally, third party software underlying our services can contain undetected errors or bugs, or be susceptible to cybersecurity breaches described above. We may be forced to delay commercial release of our services until any discovered problems are corrected and, in some cases, may need to implement enhancements or modifications to correct errors that we do not detect until after deployment of our services.

16


 

Increasing regulatory focus on privacy issues and expanding laws could impact our software products and expose us to increased liability.

Privacy and data security laws apply to our various businesses in all jurisdictions in which we operate.  In particular, clients use our software services, including Venue datarooms, to share personal data and information on a confidential basis, and such sharing may be subject to privacy and data security laws. Our global business operates in countries that have more stringent data protection laws than those in the United States. These data protection laws may be inconsistent across jurisdictions and are subject to evolving and differing interpretations. New laws, such as the General Data Protection Regulation (“GDPR”) expected to go into effect in May 2018 in Europe, and industry self-regulatory codes have been or are being enacted to protect personal data.  Complying with these regulations has been, and will continue to be, costly, and there are or will be significant penalties for failure to comply with these regulations, including significant penalties for failing to comply with GDPR.  Further, any perception of our practices, products or services as a violation of individual privacy rights may subject us to public criticism, class action lawsuits, reputational harm, or investigations or claims by regulators, industry groups or other third parties, all of which could disrupt our business and expose us to liability.

Transferring personal data and information across international borders is becoming increasingly complex. For example, Europe has stringent regulations regarding transfer of personal data and information. The mechanisms that we and many other companies rely upon for data transfers from Europe to the United States (e.g., Privacy Shield and Model Clauses) are being contested in the European court systems. We are closely monitoring developments related to requirements for transferring personal data and information. These requirements may result in an increase in the obligations required to provide our services in the EU or in sanctions and fines for non-compliance. Several other countries, including Australia and Japan, have also established specific legal requirements for cross-border transfers of personal information. These developments in Europe and elsewhere could harm our business, financial condition and results of operations.

Adverse credit market conditions may limit our ability to obtain future financing.

 

We may, from time to time, depend on access to credit markets. Uncertainty and volatility in global financial markets may cause financial markets institutions to fail or may cause lenders to hoard capital and reduce lending. As a result, we may not obtain financing on terms and conditions that are favorable to us, or at all.

Fluctuations in the costs and availability of paper, ink, energy and other raw materials may adversely impact us.

 

Increases in the costs of these inputs may increase our costs and we may not be able to pass these costs on to clients through higher prices. Moreover, rising raw materials’ costs, and any consequent impact on our pricing, could lead to a decrease in demand for our products and services.

If we are unable to protect our proprietary technology and other rights, the value of our business and our competitive position may be impaired.

 

If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products and services similar to ours, which could decrease demand for our services. We rely on a combination of patents, trademarks, licensing and other proprietary rights laws, as well as third party nondisclosure agreements and other contractual provisions and technical measures, to protect our intellectual property rights. These protections may not be adequate to prevent our competitors from copying or reverse-engineering our technology and services to create similar offerings. Additionally, any of our pending or future patent applications may not be issued with the scope of protection we seek, if at all. The scope of patent protection, if any, we may obtain from our patent applications is difficult to predict and our patents may be found invalid, unenforceable or of insufficient scope to prevent competitors from offering similar services. Our competitors may independently develop technologies that are substantially equivalent or superior to our technology. To protect our proprietary information, we require employees, consultants, advisors, independent contractors and collaborators to enter into confidentiality agreements and maintain policies and procedures to limit access to our trade secrets and proprietary information. These agreements and the other actions we take may not provide meaningful protection for our proprietary information or know-how from unauthorized use, misappropriation or disclosure. Further, existing patent laws may not provide adequate or meaningful protection in the event competitors independently develop technology, products or services similar to ours. Even if the laws governing intellectual property rights provide protection, we may have insufficient resources to take the legal actions necessary to protect our interests. In addition, our intellectual property rights and interests may not be afforded the same protection under the laws of foreign countries as they are under the laws of the United States.

17


 

We have in the past acquired and intend in the future to acquire other businesses, and we may be unable to successfully integrate the operations of these businesses and may not achieve the cost savings and increased net sales anticipated as a result of these acquisitions.

 

Achieving the anticipated benefits of acquisitions will depend in part upon our ability to integrate these businesses in an efficient and effective manner. The integration of companies that have previously operated independently may result in significant challenges, and we may be unable to accomplish the integration smoothly or successfully. In particular, the coordination of geographically dispersed organizations with differences in corporate cultures and management philosophies may increase the difficulties of integration. The integration of acquired businesses may also require the dedication of significant management resources, which may temporarily distract management’s attention from the day-to-day operations of the Company. In addition, the process of integrating operations may cause an interruption of, or loss of momentum in, the activities of one or more of the Company’s businesses and the loss of key personnel from the Company or the acquired businesses. Further, employee uncertainty and lack of focus during the integration process may disrupt the businesses of the Company or the acquired businesses. The Company’s strategy is, in part, predicated on the Company’s ability to realize cost savings and to increase net sales through the acquisition of businesses that add to the breadth and depth of the Company’s products and services. Achieving these cost savings and net sales increases is dependent upon a number of factors, many of which are beyond the Company’s control. In particular, the Company may not be able to realize the benefits of more comprehensive product and service offerings, anticipated integration of sales forces, asset rationalization and systems integration.

Our business is dependent upon brand recognition and reputation, and the failure to maintain or enhance our brand or reputation would likely have an adverse effect on our business.

 

Our brand recognition and reputation are important aspects of our business. Maintaining and further enhancing our brands and reputation will be important to retaining and attracting clients for our products. We also believe that the importance of our brand recognition and reputation for products will continue to increase as competition in the market for our products and industry continues to increase. Our success in this area will be dependent on a wide range of factors, some of which are out of our control, including the efficacy of our marketing efforts, our ability to retain existing and obtain new clients and strategic partners, human error, the quality and perceived value of our products and services, actions of our competitors and positive or negative publicity. Damage to our reputation and loss of brand equity may reduce demand for our products and services and negatively impact our results of operations, financial position and cash flow.

We may be unable to hire and retain talented employees, including management.

 

Our success depends, in part, on our general ability to attract, develop, motivate and retain highly skilled employees. The loss of a significant number of our employees or the inability to attract, hire, develop, train and retain additional skilled personnel could have a serious negative effect on our business. We believe our ability to retain our client base and to attract new clients is directly related to our sales force and client service personnel, and if we cannot retain these key employees, our business could suffer. In addition, many members of our management have significant industry experience that is valuable to our competitors. We expect that our executive officers will have non-solicitation agreements contractually prohibiting them from soliciting our clients and employees within a specified period of time after they leave Donnelley Financial. If one or more members of our senior management team leave and cannot be replaced with a suitable candidate quickly, we could experience difficulty in managing our business properly, which could negatively impact our results of operations, financial position and cash flow.

The trend of increasing costs to provide health care and other benefits to our employees and retirees may continue.

 

We provide health care and other benefits to both employees and retirees. For many years, costs for health care have increased more rapidly than general inflation in the U.S. economy. If this trend in health care costs continues, our cost to provide such benefits could increase, adversely impacting our profitability. Changes to health care regulations in the U.S. and internationally may also increase our cost of providing such benefits.

18


 

Changes in market conditions, changes in discount rates, or lower returns on assets may increase required pension and other post-retirement benefits plan contributions in future periods.

 

The funded status of our pension and other post-retirement benefits plans is dependent upon many factors, including returns on invested assets and the level of certain interest rates. As experienced in prior years, declines in the market value of the securities held by the plans coupled with historically low interest rates have substantially reduced, and in the future could further reduce, the funded status of the plans. These reductions may increase the level of expected required pension and other post-retirement benefits plan contributions in future years. Various conditions may lead to changes in the discount rates used to value the year-end benefit obligations of the plans, which could partially mitigate, or worsen, the effects of lower asset returns. If adverse conditions were to continue for an extended period of time, our costs and required cash contributions associated with pension and other post-retirement benefits plans may substantially increase in future periods.

We are exposed to risks related to potential adverse changes in currency exchange rates.

 

We are exposed to market risks resulting from changes in the currency exchange rates of the currencies in the countries in which we do business. Although operating in local currencies may limit the impact of currency rate fluctuations on the operating results of our non-U.S. activities, fluctuations in such rates may affect the translation of these results into our financial statements. To the extent borrowings, sales, purchases, net sales and expenses or other transactions are not in the applicable local currency, we may enter into foreign currency spot and forward contracts to hedge the currency risk. Management cannot be sure, however, that our efforts at hedging will be successful, and such efforts could, in certain circumstances, lead to losses.

There are risks associated with operations outside the United States.

 

We have operations outside the United States. We work with capital markets clients around the world, and in 2017 our International segment accounted for 16% of our consolidated net sales. Our operations outside of the United States are primarily focused in Europe, Asia, Canada and Latin America. As a result, we are subject to the risks inherent in conducting business outside the United States, including:

 

costs of customizing products and services for foreign countries;

 

difficulties in managing and staffing international operations;

 

increased infrastructure costs including legal, tax, accounting and information technology;

 

reduced protection for intellectual property rights in some countries;

 

potentially greater difficulties in collecting accounts receivable, including currency conversion and cash repatriation from foreign jurisdictions;

 

increased licenses, tariffs and other trade barriers;

 

potentially adverse tax consequences;

 

increased burdens of complying with a wide variety of foreign laws, including employment-related laws, which may be more stringent than U.S. laws;

 

unexpected changes in regulatory requirements;

 

political and economic instability; and

 

compliance with applicable anti-corruption and sanction laws and regulations.

We cannot be sure that our investments or operations in other countries will produce desired levels of net sales or that one or more of the factors listed above will not affect our global business.

Our reliance on strategic partnerships as part of our business strategy may adversely affect the development of our business in those areas.

 

Our business strategy includes pursuing and maintaining strategic partnerships in order to facilitate our entry into adjacent lines of business.  This approach may expose us to risk of conflict with our strategic arrangement partners and the need to divert management resources to oversee these partnership arrangements. Further, as these arrangements require cooperation with third party partners, these strategic arrangements may not be able to make decisions as quickly as we would if we were operating on our own or may take actions that are different from what we would do on a standalone basis in light of the need to consider our partners’ interests. As a result, we may be less able to respond timely to changes in market dynamics, which could have a material adverse effect on our business, financial condition and results of operations.

19


 

The ongoing effects of the Tax Act and the refinement of provisional estimates could make our results difficult to predict.

 

Our effective tax rate may fluctuate in the future as a result of the Tax Act, which was enacted on December 22, 2017. The Tax Act introduces significant changes to U.S. income tax law that will have a meaningful impact on our provision for income taxes. Accounting for the income tax effects of the Tax Act requires significant judgments and estimates in the interpretation and calculations of the provisions of the Tax Act.

 

Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our financial statements for the year ended December 31, 2017. The U.S. Treasury Department, the IRS, and other standard-setting bodies may issue guidance on how the provisions of the Tax Act will be applied or otherwise administered that may be different from our interpretation. As we collect and prepare necessary data, and interpret the Tax Act and any additional guidance issued by the IRS or other standard-setting bodies, we may make adjustments to the provisional amounts that could materially affect our financial position and results of operations as well as our effective tax rate in the period in which the adjustments are made.

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

The Company has no unresolved written comments from the SEC staff regarding its periodic or current reports under the Securities Exchange Act of 1934.

 

ITEM 2.

PROPERTIES

The Company’s corporate office is located in leased office space at 35 West Wacker Drive, Chicago, Illinois, 60601. As of December 31, 2017, the Company leased or owned 47 U.S. facilities, some of which had multiple buildings and warehouses, and these U.S. facilities encompassed approximately 1.4 million square feet. The Company leased 25 international facilities, some of which had multiple buildings and warehouses, encompassing approximately 0.1 million square feet in Europe, Asia, Canada and Latin America. Of the Company’s U.S. and international facilities, approximately 0.4 million square feet of space was owned, while the remaining 1.1 million square feet of space was leased.

 

 

ITEM 3.

For a discussion of certain litigation involving the Company, see Note 9, Commitments and Contingencies, to the Consolidated and Combined Financial Statements.

 

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

 

 

20


 

PART II

ITEM 5.

MARKET FOR DONNELLEY FINANCIAL SOLUTIONS, INC.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Principal Market

Donnelley Financial’s common stock began regular-way trading under the ticker symbol “DFIN” on the New York Stock Exchange (“NYSE”) on October 3, 2016. Below are the high and low market price per share of the Company’s common stock, as reported on the NYSE, during the year ended December 31, 2017 and the fourth quarter of 2016.

 

 

2017

 

 

2016

 

 

Low

 

 

High

 

 

Low

 

 

High

 

First Quarter

 

19.17

 

 

 

26.38

 

 

 

 

 

 

 

Second Quarter

 

19.04

 

 

 

23.49

 

 

 

 

 

 

 

Third Quarter

 

20.01

 

 

 

23.63

 

 

 

 

 

 

 

Fourth Quarter

 

18.45

 

 

 

22.49

 

 

18.54

 

 

25.02

 

Stockholders

As of February 23, 2018, there were 4,837 stockholders of record of the Company’s common stock.

Dividends

We have not paid any cash dividends and we currently do not anticipate paying any cash dividends in the foreseeable future.

Issuer Purchases Of Equity Securities

There were no repurchases of equity securities during the three months ended December 31, 2017.

Equity Compensation Plans

For information regarding equity compensation plans, see Item 12 of Part III of this Annual Report on Form 10-K


21


 

PEER PERFORMANCE TABLE

The following graph compares the cumulative total shareholder return on Donnelley Financial’s common stock from October 3, 2016, when “regular way” trading in Donnelley Financial’s common stock began on the NYSE, through December 31, 2017, with the comparable cumulative return of the Standard & Poor’s (“S&P”) SmallCap 600 Index and a selected peer group of companies. The comparison assumes all dividends have been reinvested and an initial investment of $100 on October 3, 2016. The returns of each company in the peer group have been weighted to reflect their market capitalizations. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

 

 

 

Base

 

 

 

 

 

 

 

 

 

Period

 

Quarter Ended

 

 

Year Ended

 

Company Name/Index

10/3/2016

 

12/31/2016

 

 

12/31/2017

 

Donnelley Financial Solutions

100

 

 

100.04

 

 

 

84.85

 

S&P SmallCap 600 Index

100

 

 

111.52

 

 

 

126.28

 

Peer Group

100

 

 

99.84

 

 

 

121.78

 

 

Below are the specific companies included in the peer group.

 

Peer Group Companies

 

 

Acxiom Corp

 

ePlus Inc

Advisory Board Company(a)

 

Euronet Worldwide Inc

ARC Document Solutions Inc

 

FactSet Research Systems Inc.

Bottomline Technologies Inc

 

Gartner Inc

Broadridge Financial Solutions Inc

 

Henry (Jack) & Associates Inc.

CoreLogic Inc

 

Perficient Inc

CSG Systems International Inc.

 

Resources Connection Inc

DST Systems Inc.

 

Verint Systems Inc

Dun & Bradstreet Corp

 

 

___________

 

(a)

Advisory Board Company was included through November 17, 2017, when it was acquired by OptumInsight

 

 

22


 

ITEM 6.

SELECTED FINANCIAL DATA

SELECTED FINANCIAL DATA

(in millions, except per share data)

 

 

Year Ended December 31,

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

Consolidated and combined statements of operations data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

$

1,004.9

 

 

$

983.5

 

 

$

1,049.5

 

 

$

1,080.1

 

 

$

1,085.4

 

Net earnings

 

9.7

 

 

 

59.1

 

 

 

104.3

 

 

 

57.4

 

 

 

96.3

 

Net earnings per share(a)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net earnings per share

 

0.29

 

 

 

1.81

 

 

 

3.22

 

 

 

1.77

 

 

 

2.97

 

Diluted net earnings per share

 

0.29

 

 

 

1.80

 

 

 

3.22

 

 

 

1.77

 

 

 

2.97

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated and combined balance sheet data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

893.5

 

 

 

978.9

 

 

 

817.6

 

 

 

994.2

 

 

 

880.5

 

Long-term debt

 

458.3

 

 

 

587.0

 

 

 

 

 

 

 

 

 

 

Note payable with an RRD affiliate

 

 

 

 

 

 

 

29.2

 

 

 

44.0

 

 

 

58.7

 

 

(a)

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. 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 4, 2017.

 

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.

 

Reflects results of acquired businesses from the relevant acquisition dates.

Includes the following significant items:

 

 

Pre-tax

 

 

After-tax

 

Year ended December 31, 2017

 

 

 

 

 

 

 

Spin-off related transaction expenses

$

16.5

 

 

$

9.9

 

Restructuring, impairment and other charges - net

 

7.1

 

 

 

4.2

 

Share-based compensation expense

 

6.8

 

 

 

4.1

 

Acquisition-related expenses

 

0.2

 

 

 

0.1

 

 

 

Pre-tax

 

 

After-tax

 

Year ended December 31, 2016

 

 

 

 

 

 

 

Restructuring, impairment and other charges – net

$

5.4

 

 

$

3.3

 

Spin-off related transaction expenses

 

4.9

 

 

 

3.0

 

Share-based compensation expense

 

2.5

 

 

 

1.5

 

 

 

Pre-tax

 

 

After-tax

 

Year ended December 31, 2015

 

 

 

 

 

 

 

Restructuring, impairment and other charges – net

$

4.4

 

 

$

2.8

 

Share-based compensation expense

 

1.6

 

 

 

1.0

 

23


 

 

 

Pre-tax

 

 

After-tax

 

Year ended December 31, 2014

 

 

 

 

 

 

 

Pension settlement charges

$

95.7

 

 

$

58.4

 

Restructuring, impairment and other charges – net

 

4.8

 

 

 

3.1

 

Gain on the sale of a building

 

(6.1

)

 

 

(3.7

)

Gain from the sale of an equity investment

 

(3.0

)

 

 

(1.8

)

Share-based compensation expense

 

2.1

 

 

 

1.3

 

 

 

Pre-tax

 

 

After-tax

 

Year ended December 31, 2013

 

 

 

 

 

 

 

Restructuring, impairment and other charges – net

$

13.0

 

 

$

8.0

 

Share-based compensation expense

 

2.1

 

 

 

1.3

 

 

 

24


 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of Donnelley Financial’s financial condition and results of operations should be read together with the consolidated and combined financial statements and notes to those statements included in Item 15 of Part IV, Exhibits, Financial Statement Schedules, of this Annual Report on Form 10-K.

Business

For a description of the Company’s business, segments and product and service offerings, see Item 1, Business, of Part I of this Annual Report on Form 10-K.

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, 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 no longer qualified as a related party of the Company.

 

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 4, 2017. In conjunction with the underwritten public offering, the underwriters exercised their option to purchase approximately 0.9 million Option Shares from the Company. 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

2017 Overview

Net sales increased by $21.4 million, or 2.2%, in 2017 compared to 2016.  There was a $1.8 million, or 0.2%, decrease due to changes in foreign exchange rates. Net sales increased primarily due to higher volumes in mutual funds, capital markets compliance, virtual data room services, translations services and content management, partially offset by lower volumes in capital markets transactions and healthcare.

OUTLOOK

In 2018, the Company expects net sales to increase slightly primarily due to growth in software offerings. The Company’s outlook assumes a stable capital markets environment and does not expect foreign exchange rates to have a significant impact on results.

25


 

In 2018, the Company will adopt Accounting Standards Update No. 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). The Company evaluated the impacts of ASU 2014-09 and does not expect a material change in the timing of revenue recognition for the majority of the Company’s revenue.  Revenue recognition will be accelerated for certain arrangements with multiple performance obligations as revenue will be recognized upon the completion of each performance obligation rather than upon final delivery of the printed product.  The Company also expects to accelerate the recognition of revenue for certain inventory which has been invoiced but not yet shipped at the customer’s request. Additionally, certain revenues related to virtual data room services will be deferred as a result of the new standard. Refer to Note 20, New Accounting Pronouncements, to the consolidated and combined financial statements for further detail.

The Company initiated several restructuring actions in 2016 and 2017 to further reduce the Company’s overall cost structure. These restructuring actions included the reorganization of certain functions. These actions, as well as planned actions for 2018, are expected to have a positive impact on operating earnings in 2018 and in future years.

Cash flows from operations in 2018 are expected to benefit from cost control actions, lower interest expense and a lower U.S. corporate income tax rate. The Company expects capital expenditures to be in the range of $40.0 million to $45.0 million in 2018, as compared to $27.8 million in 2017.

The Company expects to continue to incur a significant amount of spin-off related transition expenses in 2018, including information technology and other expenses.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation into Federal law referred to as the Tax Act.  The Tax Act includes a number of provisions that are effective January 1, 2018, including the lowering of the U.S. corporate income tax rate from the maximum 35% to a flat 21% and eliminating the corporate alternative minimum tax (AMT). The Tax Act also includes provisions that may partially offset the benefit of such rate reduction, including repeal of Section 199 (the deduction for domestic production activities) and limitations on certain deductions, such as net interest expense and certain employee remuneration. The Tax Act changes the current U.S. worldwide system of taxation by establishing a territorial-style system for taxing foreign-source income of domestic multinational corporations.  This allows U.S. companies to repatriate future foreign source earnings without additional U.S taxes by providing a 100% exemption for the foreign source portion of dividends from certain foreign subsidiaries. In order to transition to the territorial tax system, the Act requires companies to pay a one-time mandatory tax (“the transition tax”) on certain accumulated unremitted earnings of foreign subsidiaries, with an option to pay over eight years. The Company estimated its transition tax liability as of December 31, 2017 to be $14.2 million (which includes $0.6 million of state tax liabilities that could be due as a result of the Act) and will make an election to pay the transition tax liability in installments over eight years. Along with the change to a territorial tax system, the Tax Act creates the  base erosion anti-abuse tax (“BEAT”), a new minimum tax, and a current tax on “global intangible low-taxed income” of foreign subsidiaries (“the GILTI tax”). The Company may be subject to the BEAT and GILTI tax in a given year, but currently does not expect that either should have a material impact to the Company’s tax provision. The determination of whether the Company is subject to the BEAT or GILTI tax will be an annual analysis of several factors under the provisions, including the amount of foreign income generated by the Company’s foreign subsidiaries.

Based on its preliminary analysis of the Tax Act, the Company estimates an effective income tax rate between 29.0% and 32.0% (before discrete items) for the 2018 fiscal year. As the Company continues to analyze the full effects of the Tax Act on its financial statements, the impact of the Tax Act may differ from this estimate due to, among other things, changes in interpretations and assumptions the Company has made, Department of the U.S. Treasury IRS guidance and regulations that may be issued and actions the Company may take as a result.

Significant Accounting Policies and Critical Estimates

The preparation of financial statements in conformity with GAAP requires the extensive use of management’s estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates. Estimates are used when accounting for items and matters including, but not limited to, allowance for uncollectible accounts receivable, pension, asset valuations and useful lives, income taxes, restructuring and other provisions and contingencies.

26


 

Revenue Recognition

The Company manages highly-customized data and materials, such as Exchange Act, Securities Act and Investment Company Act filings with the SEC on behalf of our customers, manages virtual and physical data rooms and performs XBRL and related services.  Clients are provided with EDGAR filing services, XBRL compliance services and translation, editing, interpreting, proof-reading and multilingual typesetting services, among others. Our products include our ActiveDisclosure solution and our Venue Virtual Data Room product, among others. Revenue for services is recognized upon completion of the service performed or following final delivery of the related printed product.  The Company recognizes revenue for the majority of its products upon the transfer of title or risk of ownership, which is generally upon shipment to the customer. Because substantially all of the Company’s products are customized, product returns are not significant; however, the Company accrues for the estimated amount of customer credits at the time of sale. Refer to Note 2, Significant Accounting Policies, to the consolidated and combined financial statements for further discussion.

Certain revenues earned by the Company require significant judgment to determine if revenue should be recorded gross, as a principal, or net of related costs, as an agent. Billings for shipping and handling costs as well as certain postage costs and out-of-pocket expenses are recorded gross.

Refer to Note 20, New Accounting Pronouncements, to the consolidated and combined financial statements for further detail regarding the expected impact of the 2018 adoption of ASU 2014-09.

Goodwill and Other Long-Lived Assets

The Company’s methodology for allocating the purchase price of acquisitions is based on established valuation techniques that reflect the consideration of several factors, including valuations performed by third-party appraisers when appropriate. Goodwill is measured as the excess of the cost of an acquired entity over the fair value assigned to identifiable assets acquired and liabilities assumed. Goodwill is either assigned to a specific reporting unit or allocated between reporting units based on the relative fair value of each reporting unit. Based on its current organization structure, the Company has identified four reporting units for which cash flows are determinable and to which goodwill may be allocated. 

The Company performs its goodwill impairment tests annually as of October 31, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company also performs an interim review for indicators of impairment each quarter to assess whether an interim impairment review is required for any reporting unit. As part of its interim reviews, management analyzes potential changes in the value of individual reporting units based on each reporting unit’s operating results for the period compared to expected results as of the prior year’s annual impairment test. In addition, management considers how other key assumptions, including discount rates and expected long-term growth rates, used in the last annual impairment test, could be impacted by changes in market conditions and economic events. Based on these interim assessments, management concluded that as of the interim periods, no events or changes in circumstances indicated that it was more likely than not that the fair value for any reporting unit had declined below its carrying amount.

As of October 31, 2017, all four reporting units had goodwill. Each of the reporting units were reviewed for impairment using either a qualitative or quantitative assessment.

Qualitative Assessment for Impairment

The Company performed a qualitative assessment for the International reporting unit to determine whether it was more likely than not that the fair value of the reporting unit was less than its carrying value. In performing this analysis, the Company considered various factors, including the effect of market or industry changes and the reporting unit’s actual results compared to projected results. In addition, management considered how other key assumptions used in the October 31, 2016 annual goodwill impairment test could be impacted by changes in market conditions and economic events.

As part of the qualitative review of impairment, management analyzed the potential change in fair value of the International reporting unit based on its operating results for the ten months ended October 31, 2017 compared to expected results. As of October 31, 2016, the estimated fair value of the International reporting unit exceeded its carrying value by approximately 121.5%.

Based on its qualitative assessment, management concluded that as of October 31, 2017, it was more likely than not that the fair value of the International reporting unit was greater than its carrying value. The goodwill balance of the International reporting unit was $18.2 million as of October 31, 2017.

27


 

Quantitative Assessment for Impairment

For the remaining three reporting units, the estimated fair value of each reporting unit was compared to its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeded the estimated fair value, an impairment loss is generally recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The results of the quantitative assessment of goodwill impairment as of October 31, 2017, indicated that the estimated fair values for the three reporting units exceeded their respective carrying amount. Therefore, no impairment losses were recognized.

The analysis performed included estimating the fair value of each reporting unit using both the income and market approaches. The income approach requires management to estimate a number of factors for each reporting unit, including projected future operating results, economic projections, anticipated future cash flows, discount rates and the allocation of shared or corporate items. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping. The Company weighted both the income and market approach equally to estimate the concluded fair value of each reporting unit.

The determination of fair value in the quantitative assessment requires the Company to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which the Company competes; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, restructuring charges and capital expenditures.

As a result of the 2017 annual goodwill impairment test, the Company did not recognize any goodwill impairment losses as the estimated fair values of all reporting units exceeded their respective carrying amounts.

Goodwill Impairment Assumptions

Although the Company believes its estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting units, the amount of the goodwill impairment charge, or both. Future declines in the overall market value of the Company’s equity and debt securities may also result in a conclusion that the fair value of one or more reporting units has declined below its carrying amount.

One measure of the sensitivity of the amount of goodwill impairment charges to key assumptions is the amount by which each reporting unit “passed” (fair value exceeds carrying amount) or “failed” (the carrying amount exceeds fair value) the quantitative assessment. The three reporting units that were quantitatively assessed had fair values that exceeded the carrying amounts by between 34.3% and 106.6% of their respective estimated fair values. Relatively small changes in the Company’s key assumptions would not have resulted in any reporting units being impaired.

Generally, changes in estimates of expected future cash flows would have a similar effect on the estimated fair value of the reporting unit. That is, a 1.0% decrease in estimated annual future cash flows would decrease the estimated fair value of the reporting unit by approximately 1.0%. The estimated long-term net sales growth rate can have a significant impact on the estimated future cash flows, and therefore, the fair value of each reporting unit. A 1.0% decrease in the long-term net sales growth rate would have resulted in no reporting units recognizing an impairment loss. Of the other key assumptions that impact the estimated fair values, most reporting units have the greatest sensitivity to changes in the estimated discount rate. The estimated discount rate for the reporting units with operations primarily located in the U.S. ranged from 9.0% to 9.5% as of October 31, 2017. A 1.0% increase in estimated discount rates would have resulted in no reporting units recognizing an impairment loss. The Company believes that its estimates of future cash flows and discount rates are reasonable, but future changes in the underlying assumptions could differ due to the inherent uncertainty in making such estimates. Additionally, further price deterioration or lower volume could have a significant impact on the fair values of the reporting units.

28


 

Other Long-Lived Assets

The Company evaluates the recoverability of other long-lived assets, including property, plant and equipment, and certain identifiable intangible assets, whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable.  The Company performs impairment tests of indefinite-lived intangible assets on an annual basis or more frequently in certain circumstances. Factors which could trigger an impairment review include significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the assets or the strategy for the overall business, a significant decrease in the market value of the assets or significant negative industry or economic trends. When the Company determines that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the indicators, the assets are assessed for impairment based on the estimated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition.  If the carrying value of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recorded for the excess of the asset’s carrying value over its fair value. There was no impairment charge related to intangible assets for the year ended December 31, 2017.  The Company recognized non-cash impairment charges of $0.2 million related to leasehold improvements associated with facility closures for the year ended December 31, 2017.

Pension and Other Postretirement Benefits Plans

Our Participation in RRD’s Pension and Postretirement Benefits Plans

RRD provided pension and other postretirement healthcare benefits to certain current and former employees of Donnelley Financial. Donnelley Financial’s 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.

Donnelley Financial’s Pension and Other 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 Company’s primary defined benefit plan is frozen. No new employees are permitted to enter the Company’s frozen plan and participants will earn no additional benefits. Benefits are generally based upon years of service and compensation. These defined benefit retirement income plans are funded in conformity with the applicable government regulations. The Company funds at least the minimum amount required for all funded plans using actuarial cost methods and assumptions acceptable under government regulations.

The annual income and expense amounts relating to the pension plan are based on calculations which include various actuarial assumptions including, mortality expectations, discount rates and expected long-term rates of return. The Company reviews its actuarial assumptions on an annual basis as of December 31 (or more frequently if a significant event requiring remeasurement occurs) and modifies the assumptions based on current rates and trends when it is appropriate to do so. The effects of modifications are recognized immediately on the consolidated balance sheets, but are amortized into operating earnings over future periods, with the deferred amount recorded in accumulated other comprehensive income (loss).  The Company believes that the assumptions utilized in recording its obligations under its plans are reasonable based on its experience, market conditions and input from its actuaries and investment advisors. The weighted-average discount rate for pension benefits at December 31, 2017 was 3.7%.

A one-percentage point change in the discount rates at December 31, 2017 would have the following effects on the accumulated benefit obligation and projected benefit obligation:

Pension Plans

 

 

1.0%

Increase

 

 

1.0%

Decrease

 

 

(in millions)

 

Accumulated benefit obligation

$

(33.3

)

 

$

40.8

 

Projected benefit obligation

 

(33.3

)

 

 

40.8

 

 

29


 

The Company’s defined benefit plan has a risk management approach for its pension plan assets. The overall investment objective of this approach is to further reduce the risk of significant decreases in the plan’s funded status by allocating a larger portion of the plan’s assets to investments expected to hedge the impact of interest rate risks on the plan’s obligation.

The expected long-term rate of return for the plan assets is based upon many factors including expected asset allocations, historical asset returns, current and expected future market conditions and risk. In addition, the Company considered the impact of the current interest rate environment on the expected long-term rate of return for certain asset classes, particularly fixed income. The target asset allocation percentage for the pension plan was approximately 60.0% for return seeking investments and approximately 40.0% for fixed income investments. The expected long-term rate of return on plan assets assumption used to calculate net pension plan expense in 2017 was 7.0% for the Company’s pension plans. The expected long-term rate of return on plan assets assumption that will be used to calculate net pension plan expense in 2018 is 6.8%.

A 0.25% change in the expected long-term rate of return on plan assets at December 31, 2017 would have the following effects on 2017 and 2018 pension plan (income)/expense:

 

 

2017

 

 

2018

 

 

(in millions)

 

0.25% increase

$

(0.6

)

 

$

(0.6

)

0.25% decrease

 

0.6

 

 

 

0.6

 

 

Accounting for Income Taxes

In the Company’s consolidated and combined financial statements, income tax expense and deferred tax balances have been calculated on a separate income tax return basis although, with respect to certain entities, the Company’s operations prior to the Separation have historically been included in the tax returns filed by the respective RRD entities of which the Company’s business was a part. As a standalone entity post-Separation, the Company files tax returns on its own behalf and its deferred taxes and effective tax rate may differ from those in historical periods.

Significant judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. Additionally, the Company’s tax returns are subject to audit by various U.S. and foreign tax authorities. The Company recognizes a tax position in its financial statements when it is more likely than not (i.e., a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. This recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Although management believes that its estimates are reasonable, the final outcome of uncertain tax positions may be materially different from that which is reflected in the Company’s historical financial statements.

The Company has recorded deferred tax assets related to future deductible items, including domestic and foreign tax loss and credit carryforwards. The Company evaluates these deferred tax assets by tax jurisdiction. The utilization of these tax assets is limited by the amount of taxable income expected to be generated within the allowable carryforward period and other factors. Accordingly, management has provided a valuation allowance to reduce certain of these deferred tax assets when management has concluded that, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be fully realized. If actual results differ from these estimates, or the estimates are adjusted in future periods, adjustments to the valuation allowance might need to be recorded. As of December 31, 2017 and 2016, valuation allowances of $1.5 million and $1.2 million, respectively, were recorded in the Company’s consolidated balance sheets.

30


 

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period of one year from the Tax Act enactment date for companies to complete their accounting of the tax effects of the Tax Act. As stated by SAB 118, companies must reflect the income tax effects of those aspects of the Act for which the accounting is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply its accounting on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

As a result of the reduction in the U.S. corporate income tax rate from 35% to 21% pursuant to the Tax Act, the Company has revalued its U.S. net deferred tax assets at December 31, 2017. The Company has estimated a reduction in the value of its net deferred tax asset of approximately $8.2 million, which has been recorded as additional deferred income tax expense in the Company’s consolidated statement of operations for the year ended December 31, 2017. Due to the transition to a territorial tax system under the Tax Act, the Company will be deemed to repatriate its foreign subsidiaries’ untaxed accumulated earnings and pay a mandatory U.S. federal tax of 15.5% on the portion of the earnings that are in cash and cash equivalents and 8% on the portion of earnings that are in non-cash and non-cash equivalent assets. The Company has estimated the U.S. federal and state tax liability to be approximately $14.2  million (includes $0.6 million of state tax liabilities that could be due as a result of the Act) which has been recorded as income tax expense in the consolidated statement of operations for the year ended December 31, 2017.

The Company’s revaluation of its net deferred tax asset as well as the calculation of the mandatory deemed repatriation tax are subject to further refinement as additional information on the specifics of the Tax Act becomes available and as further analysis is completed by the Company. As such and in accordance with SAB 118, the deferred and current income tax expense associated with the revaluation of the Company’s net deferred tax asset and the mandatory tax in the Company’s consolidated statement of operations as of December 31, 2017 are provisional estimates at this time. Pursuant to SAB 118, the Company will complete the accounting for these items within the twelve month measurement period.

Refer to Note 11, Income Taxes, to the consolidated and combined financial statements for further detail on the accounting for income taxes and SAB 118.

Commitments and Contingencies

The Company is subject to lawsuits, investigations and other claims related to environmental, employment, commercial and other matters, as well as preference claims related to amounts received from customers and others prior to their seeking bankruptcy protection. Periodically, the Company reviews the status of each significant matter and assesses potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the related liability is estimable, the Company accrues a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the related potential liability and may revise its estimates.

With respect to claims made under the Company’s third-party insurance for workers’ compensation, automobile and general liability, the Company is responsible for the payment of claims below and above insured limits, and consulting actuaries are utilized to assist the Company in estimating the obligation associated with any such incurred losses, which are recorded in accrued and other non-current liabilities. Historical loss development factors for both the Company and the industry are utilized to project the future development of such incurred losses, and these amounts are adjusted based upon actual claims experience and settlements. If actual experience of claims development is significantly different from these estimates, an adjustment in future periods may be required. Expected recoveries of such losses are recorded in other current and other non-current assets.

Restructuring

The Company records restructuring charges when liabilities are incurred as part of a plan approved by management with the appropriate level of authority for the elimination of duplicative functions, the closure of facilities, or the exit of a line of business, generally in order to reduce the Company’s overall cost structure. Total restructuring charges were $6.7 million for the year ended December 31, 2017. The restructuring liabilities might change in future periods based on several factors that could differ from original estimates and assumptions. These include, but are not limited to: contract settlements on terms different than originally expected; ability to sublease properties based on market conditions at rates or on timelines different than originally estimated; or changes to original plans as a result of acquisitions or other factors. Such changes might result in reversals of or additions to restructuring charges that could affect amounts reported in the consolidated and combined statements of operations of future periods.

31


 

Accounts Receivable

The Company maintains an allowance for doubtful accounts receivable to account for estimated losses resulting from the inability of its customers to make required payments for products and services. Specific customer provisions are made when a review of significant outstanding amounts, utilizing information about customer creditworthiness and current economic trends, indicates that collection is doubtful. In addition, provisions are made at differing rates, based upon the age of the receivable and the Company’s past collection experience. The allowance for doubtful accounts receivable was $7.3 million at December 31, 2017 and $6.4 million at December 31, 2016. The Company also maintains a reserve for potential credit memos and disputed items. The credit memo and disputed items reserve is based on historical credit memos relative to billings as well as specific customer reserves and was $7.4 million at December 31, 2017 and $9.3 million at December 31, 2016. The Company’s estimates of the recoverability of accounts receivable could change, and additional changes to the allowance could be necessary in the future, if any major customer’s creditworthiness deteriorates or actual defaults are higher than the Company’s historical experience.

Share-Based Compensation

Prior to the Separation, RRD maintained an incentive share-based compensation program for the benefit of its officers, directors, and certain employees including certain Donnelley Financial employees.  In periods prior to the Separation, share-based compensation expense was allocated to the Company based on the awards and terms previously granted to the Company’s employees as well as an allocation of compensation expense related to RRD’s corporate and shared functional employees.  

Subsequent to the Separation, the amount of expense recognized for share-based awards is determined by the Company’s estimates of several factors, including future forfeitures of awards and expected volatility of the Company’s stock. The total compensation expense related to all share-based compensation plans was $6.8 million for the year ended December 31, 2017.  See Note 14, Share-based Compensation, to the Consolidated and Combined Financial Statements for further discussion.

Off-Balance Sheet Arrangements

Other than non-cancelable operating lease commitments, the Company does not have off-balance sheet arrangements, financings or special purpose entities.

Financial Review

In the financial review that follows, the Company discusses its 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 consolidated and combined financial statements and the related notes.

32


 

Results of Operations for the Year Ended December 31, 2017 as Compared to the Year Ended December 31, 2016

The following table shows the results of operations for the years ended December 31, 2017 and 2016:

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

(in millions, except percentages)

 

Services net sales

$

632.1

 

 

$

598.6

 

 

$

33.5

 

 

 

5.6

%

Products net sales

 

372.8

 

 

 

384.9

 

 

 

(12.1

)

 

 

(3.1

%)

Net sales

 

1,004.9

 

 

 

983.5

 

 

 

21.4

 

 

 

2.2

%

Services cost of sales (exclusive of depreciation and amortization)

 

328.7

 

 

 

297.1

 

 

 

31.6

 

 

 

10.6

%

Services cost of sales with RRD affiliates (exclusive of depreciation and amortization)*

 

19.5

 

 

 

37.8

 

 

 

(18.3

)

 

 

(48.4

%)

Products cost of sales (exclusive of depreciation and amortization)

 

240.9

 

 

 

226.2

 

 

 

14.7

 

 

 

6.5

%

Products cost of sales with RRD affiliates (exclusive of depreciation and amortization)*

 

32.3

 

 

 

57.9

 

 

 

(25.6

)

 

 

(44.2

%)

Cost of sales

 

621.4

 

 

 

619.0

 

 

 

2.4

 

 

 

0.4

%

Selling, general and administrative expenses (exclusive of depreciation and amortization)

 

232.9

 

 

 

209.8

 

 

 

23.1

 

 

 

11.0

%

Restructuring, impairment and other charges-net

 

7.1

 

 

 

5.4

 

 

 

1.7

 

 

 

31.5

%

Depreciation and amortization

 

44.5

 

 

 

43.3

 

 

 

1.2

 

 

 

2.8

%

Income from operations

$

99.0

 

 

$

106.0

 

 

$

(7.0

)

 

 

(6.6

%)

 

 

* Beginning in the quarter ended June 30, 2017, LSC no longer qualified as a related party, therefore the 2017 amounts disclosed related to LSC are presented through March 31, 2017 only. Beginning in the quarter ended September 30, 2017, RRD no longer qualified as a related party, therefore the amounts disclosed related to RRD are presented through June 30, 2017 only.

 

Consolidated and Combined

 

Net sales of services for the year ended December 31, 2017 increased $33.5 million, or 5.6%, to $632.1 million, versus the year ended December 31, 2016 including a $1.0 million, or 0.2%, decrease due to changes in foreign exchange rates. Net sales of services increased due to higher volumes in virtual data room services, mutual fund print-related services, translations services and content management, partially offset by lower capital markets compliance volumes.

 

Net sales of products for the year ended December 31, 2017 decreased $12.1 million, or 3.1%, to $372.8 million versus the year ended December 31, 2016, including a $0.8 million, or 0.2%, decrease due to changes in foreign exchange rates. Net sales of products decreased due to lower capital markets transactions volumes, healthcare volumes and price pressures in investment markets, partially offset by higher capital markets compliance and mutual fund print volumes.

Services cost of sales increased $13.3 million, or 4.0%, for the year ended December 31, 2017, versus the year ended December 31, 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 decreased 0.8% due to favorable mix and cost control initiatives.

Products cost of sales decreased $10.9 million, or 3.8%, for the year ended December 31, 2017, versus the year ended December 31, 2016.  Products cost of sales decreased due to lower capital markets transaction and healthcare volumes and cost control initiatives. As a percentage of net sales, products cost of sales decreased 0.5% primarily due to a favorable mix of product sales and cost control initiatives.

Selling, general and administrative expenses for the year ended December 31, 2017 increased $23.1 million, or 11.0%, to $232.9 million, as compared to the year ended December 31, 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 21.3% for the year ended December 31, 2016 to 23.2% for year ended December 31, 2017 primarily due to increased costs of operating as an independent public company, including spin-off related transaction expenses.

33


 

For the year ended December 31, 2017, the Company recorded net restructuring, impairment and other charges of $7.1 million compared to $5.4 million for the year ended December 31, 2016. For the year ended December 31, 2017, these charges included $6.4 million of employee termination costs for 192 employees, substantially all of whom were terminated as of December 31, 2017. These charges primarily related to the reorganization of certain operations and certain administrative functions. During the year ended December 31, 2017, the Company also incurred $0.3 million of lease termination and other restructuring costs, $0.2 million of net impairment charges primarily related to leasehold improvements associated with facility closures and $0.2 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 year ended December 31, 2016, these charges included $3.7 million of employee termination costs for 84 employees, all of whom were terminated as of December 31, 2016.  These charges were primarily the result of the reorganization of certain administrative functions.  The Company also incurred lease termination and other restructuring charges of $1.5 million and other charges of $0.2 million associated with the Company’s decision to withdraw in 2013 from certain multi-employer pension plans during the year ended December 31, 2016.

Depreciation and amortization for the year ended December 31, 2017 increased $1.2 million, or 2.8%, to $44.5 compared to the year ended December 31, 2016.  Depreciation and amortization included $15.0 million and $14.4 million of amortization of other intangible assets related to customer relationships, trade names and non-compete agreements for the years ended December 31, 2017 and 2016, respectively.

Income from operations for the year ended December 31, 2017 decreased $7.0 million, or 6.6%, to $99.0 million versus the year ended December 31, 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 capital markets compliance, virtual data room services, mutual funds print-related services and content management.

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

(in millions, except percentages)

 

Interest expense-net

$

42.9

 

 

$

11.7

 

 

$

31.2

 

 

 

266.7

%

 

Net interest expense increased by $31.2 million for the year ended December 31, 2017 versus the year ended December 31, 2016, due to the issuance of debt in connection with the Separation. Refer to “Liquidity and Capital Resources” for further discussion.

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

(in millions, except percentages)

 

Earnings before income taxes

$

56.2

 

 

$

94.3

 

 

$

(38.1

)

 

 

(40.4

%)

Income tax expense

 

46.5

 

 

 

35.2

 

 

 

11.3

 

 

 

32.1

%

Effective income tax rate

 

82.7

%

 

 

37.3

%

 

 

 

 

 

 

 

 

 

The effective income tax rate was 82.7% for the year ended December 31, 2017 compared to 37.3% for the year ended December 31, 2016. The 2017 effective income tax rate is higher as compared to the 2016 effective income tax rate primarily due to impacts of the recent changes to U.S. tax legislation as a result of the enactment of the Tax Act, including the transition tax imposed on the Company's accumulated foreign earnings and the remeasurement of the Company's U.S net deferred tax asset. The 2017 effective income tax rate was also impacted by non-deductible expenses incurred by the Company in 2017 which were previously incurred by RRD on behalf of the Company during pre-Separation periods, as well as a one-time favorable change in a valuation allowance in 2016 not present in 2017.

 

34


 

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.

 

 

Year Ended December 31,

 

 

2017

 

 

2016

 

 

(in millions, except percentages)

 

Net sales

$

847.9

 

 

$

845.2

 

Income from operations

 

127.6

 

 

 

118.4

 

Operating margin

 

15.0

%

 

 

14.0

%

Restructuring, impairment and other charges-net

 

3.9

 

 

 

4.7

 

Spin-off related transaction expenses

 

10.0

 

 

 

0.3

 

 

 

Net Sales for the

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

 

 

Reporting unit

2017