Business context and reporting period
Quad/Graphics, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2014. The company provides commercial printing, media and logistics services, primarily through its U.S. Print and Related Services segment; International represented about 11% of quarterly sales. Results are seasonal, with sales and operating income generally higher in the third and fourth quarters.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $1,102.8 million | $1,129.5 million |
| Operating income (loss) | $11.0 million | $(0.9) million |
| Operating margin | 1.0% | (0.1)% |
| Net loss attributable to Quad/Graphics shareholders | $(8.8) million | $(14.0) million |
| Diluted loss per share | $(0.19) | $(0.31) |
| EBITDA (non-GAAP) | $94.7 million | $88.2 million |
| Cash provided by operating activities | $33.0 million | $121.4 million |
| Capital expenditures | $45.8 million | $28.3 million |
| Free cash flow (non-GAAP) | $(12.8) million | $93.1 million |
Cash and cash equivalents were $13.1 million at March 31, 2014. Total debt was $1,432.1 million; debt and capital lease obligations together were $1,449.9 million. Current assets were $1,015.2 million and current liabilities $806.5 million. The company reported $545.0 million of unused revolving-credit capacity, net of letters of credit.
Dividends declared were $0.30 per share, unchanged year over year. The company’s non-GAAP Debt Leverage Ratio was 2.55x, versus 2.44x at December 31, 2013; management’s target range was 2.0x–2.5x.
Material changes versus the prior comparable period
- Sales declined 2.4%, mainly from printing-industry volume and pricing pressure, lower paper sales and foreign-exchange effects; acquisitions partly offset the decline. Product sales fell 2.9%, while service sales rose 1.4%.
- Operating income improved by $11.9 million, but the comparison was substantially affected by lower restructuring, impairment and transaction-related charges: $11.9 million versus $25.9 million. Excluding these charges, management said operating income declined $2.1 million, chiefly because of volume and pricing pressure and nonrecurring 2013 gains, partly offset by lower employee costs.
- EBITDA increased $6.5 million and EBITDA margin rose to 8.6% from 7.8%, primarily reflecting lower charges and SG&A, partly offset by lower sales.
- Operating cash flow fell $88.4 million and free cash flow fell $105.9 million. The comparison included an estimated $70 million working-capital benefit in Q1 2013 following the Vertis acquisition; 2014 also had higher capital spending and working-capital cash use.
- Debt and capital lease obligations rose $43.1 million from year-end, mainly to fund capital spending, acquisitions and seasonal working capital needs.
Outlook, commentary, risks and unusual items
- Management expected 2014 capital expenditures of $150–$175 million; $45.8 million was spent in Q1. The company expected continued seasonality and additional restructuring and integration costs.
- On April 7, 2014, Quad/Graphics announced a pending $100 million acquisition of Brown Printing, subject to customary conditions and regulatory approvals. On April 28, it completed new $1.6 billion senior secured credit facilities and issued $300 million of 7.0% senior notes due 2022. Proceeds were intended to refinance existing debt, fund the Brown Printing acquisition and support general corporate purposes.
- At March 31, the company was in compliance with debt covenants. Its reported covenant leverage ratio was 2.48x against a maximum of 3.50x; interest coverage was 7.36x against a 3.50x minimum. The new financing has different covenant terms, including a senior secured leverage covenant.
- Key industry risks include excess printing capacity, price competition, digital substitution, postal-rate increases, changing demand, input and energy costs, customer contract and credit risk, and challenges integrating acquisitions. USPS implemented a temporary 6.0% exigent postage increase in January 2014; management cautioned that higher postal costs could reduce demand for print and mail.
- The company had reserved $69.4 million for multiemployer pension-plan withdrawal liabilities and was in arbitration over the final amounts; the estimate could change. World Color Press bankruptcy claims also remain unresolved: $55.9 million of restricted cash was held for Class 3 claims, and the company noted that estimated cash claims could exceed recorded amounts.
- Management considered ordinary-course litigation and environmental matters not expected to have a material financial impact. No material risk-factor changes were reported for the quarter. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales and underlying operating performance stabilize despite ongoing printing-volume and pricing pressure.
- Whether operating cash flow recovers after the unusually favorable Q1 2013 working-capital comparison, and how planned capital spending affects free cash flow and leverage.
- Completion, financing and integration of the Brown Printing acquisition, including its effect on debt, capacity and cost savings.
- Final outcomes and potential cash or accounting effects of the multiemployer pension arbitration and World Color Press bankruptcy claims.
- Compliance with the new debt covenants and the effect of refinancing costs, interest rates and restricted-payment provisions.