Quad/Graphics, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2015. Quad/Graphics provides commercial printing and related marketing, logistics, data and digital services, principally through its U.S. Print and Related Services segment and International segment. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise indicated.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $1,156.0 | $1,236.4 | $3,343.0 | $3,438.2 |
| Operating income (loss) | $(772.1) | $53.6 | $(809.7) | $65.1 |
| Net earnings (loss) attributable to common shareholders | $(552.2) | $24.4 | $(632.5) | $(7.2) |
| Diluted earnings (loss) per share | $(11.50) | $0.50 | $(13.20) | $(0.16) |
| Net cash provided by operating activities | Not provided for the quarter | Not provided for the quarter | $179.2 | $74.8 |
- Revenue and margins: Q3 sales fell 6.5% year over year; nine-month sales fell 2.8%. Product sales declined 6.5% in Q3 and 3.0% year to date, reflecting lower print volumes, pricing pressure and foreign exchange; acquisitions partly offset declines. Service sales decreased 6.4% in Q3 and 1.1% year to date. Reported operating margin was negative 66.8% in Q3 and negative 24.2% for nine months, heavily affected by goodwill impairment. Cost of sales was 80.5% of sales in Q3 versus 79.1% a year earlier, and 80.9% year to date versus 80.4%.
- Impairments and adjusted measure: Quad recorded $775.0 million of non-cash U.S. goodwill impairment in Q3 and $798.3 million for the first nine months, including $23.3 million for Latin America. Reported EBITDA, a non-GAAP measure, was $(693.8) million in Q3 versus $136.9 million, and $(570.1) million year to date versus $308.0 million. The impairment is a major reason for the reported losses; management also cited weaker industry volumes and pricing and higher labor costs as pressures on underlying operating performance.
- Cash flow and investment: Nine-month operating cash flow was $179.2 million. Capital spending was $111.2 million, resulting in company-defined free cash flow of $68.0 million, compared with $(38.3) million in the prior-year period. The cash flow improvement chiefly reflected working-capital changes and a $10.0 million cash receipt related to Courier’s terminated acquisition agreement. Investing activities used $233.8 million, including $140.8 million for acquisitions. Cash and cash equivalents were $14.2 million at September 30, 2015.
- Debt and liquidity: Total debt was $1,504.8 million, including $94.3 million current debt; long-term debt was $1,410.5 million. Debt and capital lease obligations used in management’s leverage calculation totaled $1,518.7 million. The company reported $573.5 million of unused revolver capacity, net of letters of credit. Its non-GAAP Debt Leverage Ratio was 3.09x, above management’s 2.0x–2.5x target range and up from 2.57x at year-end 2014. Covenant total leverage was 3.05x against a 3.75x maximum; senior secured leverage was 2.46x against 3.50x; interest coverage was 5.86x against a 3.50x minimum. The company reported compliance with all financial covenants.
- Other balance-sheet items: Total assets were $3,123.9 million and shareholders’ equity was $450.8 million, down from $4,057.2 million and $1,152.5 million, respectively, at December 31, 2014. The decline principally reflects the impairment and year-to-date loss.
Material changes versus the prior comparable periods
- Q3 revenue decreased $80.4 million; management attributed the decline mainly to a sharper-than-expected industry volume pullback and pricing pressure. For nine months, revenue was down $95.2 million, as acquisitions partially offset declines in established print operations and foreign exchange.
- Operating results shifted to substantial losses after goodwill impairment, while restructuring, impairment and transaction-related charges rose to $35.6 million in Q3 and $80.0 million year to date, from $14.1 million and $45.9 million, respectively.
- Excluding restructuring, impairment and goodwill impairment charges, management said operating income declined $29.2 million in Q3 and $42.4 million for nine months. Cited causes included lower volumes and pricing, and higher labor costs associated with lower productivity.
- Debt and capital lease obligations increased about $113 million from year-end, primarily to fund the Marin’s, Copac and Specialty acquisitions and seasonal working-capital needs. The company completed those acquisitions during 2015 and sold its Chile equity-method investment for $10.5 million.
- Operating cash flow improved by $104.4 million year over year for nine months, largely due to working-capital changes and the Courier termination-fee receipt; this improvement should be considered alongside weak reported earnings and the timing-sensitive nature of working capital.
Outlook, management commentary, risks and unusual items
- Outlook and plans: The filing gives no specific revenue or earnings guidance. Management expected seasonal patterns to continue: sales and operating income are generally higher in the third and fourth quarters, and operating cash flow is typically highest in the fourth quarter. Quad planned $140–$145 million of capital investment for 2015, after spending $111 million in the first nine months, including a digital book-press program; six high-speed digital web presses had been installed by September 30.
- Cost program and restructuring: Management described a recently announced $100 million sustainable cost-reduction program involving capacity reductions, productivity initiatives, lower selling, general and administrative costs, and organizational streamlining. The company announced four plant closures during the first nine months and said additional restructuring and integration charges are expected. Since 2010, it had announced 29 plant closures and reduced headcount by approximately 9,500.
- Industry and operating risks: Management highlighted declining print demand, excess industry capacity and pricing pressure; digital substitution; customer contract and credit risks; postal-rate changes; labor, energy, freight and raw-material costs; foreign currency and international-market risks; and the need for ongoing technology and capital investment. The U.S. Postal Service’s temporary 4.3% exigent rate increase was extended through March 2016.
- Goodwill valuation: The $775.0 million U.S. impairment was based on preliminary estimates, after all three U.S. reporting units failed the first step of impairment testing following a stock-price decline and lower expected revenue, profitability and cash flows. A third-party valuation was underway; the company said the charge could be adjusted when valuation work was finalized in Q4 2015.
- Contingencies: Management did not expect ordinary-course litigation or environmental matters to materially affect the financial statements. The amount ultimately payable for World Color Press bankruptcy claims remains uncertain; recorded liabilities may be exceeded. Quad had reserved $49.7 million for multiemployer pension-plan withdrawal liability and was litigating with plan trustees over the final amount and payment period.
- Unusual regulatory disclosure: On November 2, 2015, the company reported a voluntary self-disclosure to OFAC concerning a pre-acquisition Marin’s distribution agreement that included Iran in a distributor’s territory. Quad said it discovered the agreement in post-acquisition diligence, found no Iran-related transactions after acquiring Marin’s, amended the agreement to exclude Iran, and could not predict when OFAC’s review would conclude.
- Dividends: Quad declared a $0.30-per-share quarterly dividend on November 3, 2015, payable December 18. Because covenant leverage exceeded 3.00x, restrictions on annual dividends, repurchases and certain other payments were applicable; the facility caps such payments at $120 million annually under the stated conditions.
Most important facts for investors to verify
- Final Q4 2015 valuation of the U.S. reporting units and any adjustment to the $775.0 million goodwill impairment.
- Whether operating trends in print volumes, pricing, labor productivity and margins improve, and whether the $100 million cost program delivers the planned savings.
- Future cash conversion, including the sustainability of working-capital benefits, seasonal cash flows, capital spending and acquisition-related requirements.
- Debt reduction and covenant headroom, including the implications of leverage above management’s target and applicable dividend and repurchase restrictions.
- Final outcomes and cash exposure for World Color Press bankruptcy claims and multiemployer pension withdrawal-liability litigation.
- OFAC’s conclusion regarding the Marin’s distribution agreement, and any resulting consequences.
- Progress integrating Marin’s, Copac and Specialty, and the final purchase-price allocations, which were still preliminary.