QUAD

Quad/Graphics, Inc. 10-Q Summary

Business Context and Reporting Period

This filing covers the quarterly period ended September 30, 2010. The reporting period is significantly impacted by the acquisition of World Color Press (WCP), which closed on July 2, 2010. WCP is a provider of print and digital services in North America and Latin America. Following the acquisition, Quad/Graphics' Class A common stock began trading on the NYSE under the symbol "QUAD" on July 6, 2010. The company operates in two primary segments: North America Print and Related Services and International.

Key Financial Metrics

Note: Net loss is heavily influenced by a one-time income tax expense of $200.5 million related to the conversion from S corporation to C corporation status upon the WCP acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 156.3% for the quarter and 57.3% for the nine-month period compared to 2009, primarily driven by the inclusion of WCP sales ($711.8 million in Q3).
• Profitability Decline: Operating income turned negative from a profit of $41.6 million in Q3 2009 to a loss of $4.5 million in Q3 2010. This is largely due to $74.0 million in restructuring, impairment, and transaction-related charges for the quarter.
• Restructuring Charges: Charges included $32.1 million in transaction costs, $21.5 million in employee terminations, and $6.4 million in impairment charges (Reno, Nevada plant closure). For the nine months, total charges were $111.6 million.
• Debt Increase: Total debt increased from $849.8 million at year-end 2009 to $1,698.3 million at September 30, 2010, following a new $1.23 billion debt financing agreement to fund the acquisition.
• Tax Status Change: The company transitioned from S corporation to C corporation status, resulting in significant deferred tax liabilities and a large current tax expense.

Guidance, Outlook, and Risks

• Integration Synergies: Management expects to realize pre-tax cost synergy savings of $225 million on an annual run-rate basis within 24 months of the acquisition. Total integration costs are estimated between $195 million and $240 million.
• Plant Closures: The company announced closures of facilities in Reno, Nevada; Clarksville, Tennessee; Corinth, Mississippi; Cincinnati, Ohio; and Pila, Poland to streamline operations. Additional closures were announced subsequent to the period end (St. Jean, Quebec).
• Debt Covenants: The company is subject to financial covenants including a maximum leverage ratio of 3.75:1.00 (current ratio: 2.65:1.00) and a minimum interest coverage ratio of 3.00:1.00 (current ratio: 5.47:1.00). The company was in compliance as of September 30, 2010.
• Risks: Key risks include the failure to achieve expected synergies, integration challenges, ongoing bankruptcy claim resolutions from WCP (estimated $39.0 million in priority cash claims and up to $75.0 million in unsecured notes), and industry pricing pressures due to overcapacity.

Investor Verification Checklist

• Acquisition Accounting: Verify the final purchase price allocation for World Color Press, particularly the valuation of goodwill ($744.7 million preliminary) and intangible assets.
• Tax Liability: Confirm the final impact of the S-corp to C-corp conversion on future tax obligations and deferred tax assets/liabilities.
• Bankruptcy Claims: Monitor the resolution of WCP bankruptcy claims, specifically the potential for the $75 million unsecured note cap to be fully utilized.
• Restructuring Execution: Track the actual cash outflows for the announced plant closures and workforce reductions against the estimated $195-$240 million integration cost range.
• Debt Compliance: Monitor quarterly leverage and interest coverage ratios to ensure continued compliance with the $1.23 billion credit facility covenants.