Quad/Graphics, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited. Dollar amounts are in millions unless otherwise stated.
Business context and reporting period
Quad/Graphics provides commercial printing and related marketing, logistics, digital, data and creative services. Its United States Print and Related Services segment generated about 91% of sales; International generated about 9%. Results are seasonal: sales and operating income typically rise in the third and fourth quarters, while fourth-quarter operating cash flow benefits from lower working-capital needs.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1,056.4 | $1,135.5 | $3,131.2 | $3,283.5 |
| Operating income (loss) | $33.8 | $(772.1) | $60.1 | $(809.7) |
| Operating margin | 3.2% | (68.0)% | 1.9% | (24.7)% |
| Net earnings (loss) | $11.3 | $(552.2) | $7.4 | $(632.5) |
| Diluted earnings (loss) per share | $0.22 | $(11.50) | $0.15 | $(13.20) |
| EBITDA and EBITDA margin (non-GAAP) | $95.5; 9.0% | $(693.8); (61.1)% | $289.3; 9.2% | $(570.1); (17.4)% |
- Q3 gross profit was $231.5 (21.9% of sales), compared with $225.6 (19.9%) a year earlier. Nine-month gross profit was $681.8 (21.8%), versus $640.5 (19.5%).
- Sales declined 7.0% in Q3 and 4.6% year to date. Management attributed the decline mainly to lower core and specialty print volume and pricing, lower pass-through paper sales, and foreign exchange; acquisitions partly offset the decline.
- Nine-month net cash from operations was $260.0, versus $179.2. Capital expenditures were $57.7, producing non-GAAP free cash flow of $202.3, compared with $68.0. Management cited lower working capital and reduced capital spending.
- At September 30, cash was $11.5; total debt was $1,157.0 and capital lease obligations were $15.8. The company reported $705.9 of covenant-adjusted available liquidity, including $754.4 of unused revolving capacity before the effect of more restrictive covenant limits.
- Debt leverage ratio, a company-defined non-GAAP measure, was 2.37x, down from 2.88x at year-end 2015. The company reported compliance with its financial covenants; covenant total leverage was 2.36x, senior secured leverage 1.88x, and interest coverage 6.61x.
Material changes versus the prior comparable period
- The return to reported operating and net income primarily reflects the absence of the 2015 non-cash goodwill impairment charges: $775.0 in Q3 and $798.3 for the nine-month period. All remaining goodwill was impaired in Q4 2015.
- Management said operating income excluding restructuring, impairment and transaction-related charges improved by $21.4 in Q3 and $53.9 for the nine months. Cost reductions, productivity and lower depreciation and amortization contributed; lower print volume and pricing and higher SG&A partly offset gains.
- Nine-month interest expense declined $7.5 to $58.9. Quad repurchased $56.5 of senior unsecured notes and redeemed $60.1 under its master note agreement, recording a $14.1 gain on debt extinguishment.
- The company paid $44.0 in cash dividends during the first nine months and repurchased $8.8 of shares. It declared a further $0.30-per-share quarterly dividend on October 31, 2016.
Outlook, commentary, risks and unusual items
- No specific financial guidance or forecast is provided in the supplied filing text. Management expects seasonal patterns to continue and expects further restructuring charges as it removes excess capacity and aligns costs.
- Management cited persistent industry overcapacity, declining print demand and price pressure from digital substitution. Other risks include client retention and credit, labor, energy and raw-material costs, postal rates and service levels, foreign-exchange and international-market exposure, and debt covenant restrictions.
- Restructuring, impairment and transaction-related charges were $26.1 in Q3 and $62.4 year to date. The 2016 nine-month amount included an $11.2 increase in estimated multiemployer pension withdrawal liability, a $6.5 non-cash pension settlement charge, and $12.1 of land and building impairment related to the Atglen, Pennsylvania plant closure.
- Quad self-reported potential Foreign Corrupt Practices Act issues concerning its Peru operations to the SEC and Department of Justice in April 2016 and is cooperating with both agencies. Management did not anticipate a material adverse business or financial effect at the filing date.
- The company’s estimated multiemployer pension withdrawal liability was $50.3; litigation continues, and a federal court ruling favored the GCC plan during Q3, subject to the company’s right to appeal. Final liability may differ from the estimate.
- Remaining World Color Press bankruptcy claims could require payments or expense beyond recorded estimates. Ordinary-course litigation and environmental matters were not expected by management to have a material financial effect.
- The company stated that its disclosure controls were effective and that no material change in internal control occurred during the quarter.
Important facts for investors to verify
- Whether print volume and pricing declines continue, and whether cost reductions can offset them without impairing service or future capacity.
- Underlying operating performance apart from the 2015 goodwill impairment and recurring or continuing restructuring costs; EBITDA and free cash flow are non-GAAP measures.
- Cash generation, seasonal working-capital needs, capital spending and the sustainability of the reported free cash flow.
- Debt reduction, revolving-credit availability, covenant headroom, and the company’s ability to maintain dividends while meeting pension and debt obligations.
- Developments in the Peru FCPA inquiry, multiemployer pension litigation and unresolved bankruptcy claims, including any change in estimated liabilities.