Quad/Graphics, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Quad provides print, logistics, imaging and marketing services in the United States and internationally. Its U.S. Book business is reported as discontinued operations; continuing-operations comparisons exclude that business.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $584.5 million | $948.9 million | $1,407.0 million | $1,909.9 million |
| Operating income (loss), continuing operations | $(2.8) million | $18.7 million | $2.2 million | $35.1 million |
| Net loss attributable to Quad shareholders | $(23.5) million | $(14.8) million | $(35.9) million | $(37.3) million |
| Basic and diluted loss per share | $(0.46) | $(0.30) | $(0.71) | $(0.75) |
| EBITDA and margin (non-GAAP) | $35.1 million; 6.0% | $60.7 million; 6.4% | $87.0 million; 6.2% | $107.0 million; 5.6% |
- Q2 sales fell 38.4% year over year; first-half sales fell 26.3%. The filing attributes declines to COVID-19 impacts, print volume and pricing pressure, lower pass-through paper sales, and the Omaha packaging-plant divestiture. Service sales also weakened, particularly logistics.
- Q2 operating margin from continuing operations was negative 0.5%, versus 2.0% a year earlier; first-half margin was 0.2%, versus 1.8%. Q2 operating results turned to a loss despite lower SG&A and cost of sales, as volume and pricing pressure and higher restructuring charges weighed on performance.
- Operating cash flow was $67.2 million in the first half, versus $16.3 million. Capital expenditures were $38.0 million, producing reported non-GAAP free cash flow of $29.2 million, versus negative $49.8 million. The filing says operating cash flow improvement reflected changes in operating assets and liabilities and cash from earnings.
- Cash was $70.2 million at June 30, down from $78.7 million at year-end. Total debt was $1,041.6 million; debt and finance lease obligations totaled $1,047.6 million. The company reported a non-GAAP debt leverage ratio of 3.37x, or 3.18x net of excess cash, compared with 3.32x and 3.12x at year-end.
- Reported liquidity was $534.7 million, including $70.2 million cash and $464.5 million of unused revolving capacity net of letters of credit. Under the most restrictive debt covenants, liquidity was $434.8 million, including $364.6 million available on the revolver. No revolver borrowings were outstanding at quarter-end.
Material changes and notable items
- COVID-19 drove severe sales and operating pressure. Quad instituted furloughs, temporary executive and director pay reductions, facility production suspensions, delayed capital spending and other cost and cash conservation measures. It permanently closed its Taunton, Massachusetts retail facility and said further cost reductions may be implemented.
- Restructuring, impairment and transaction-related charges were $16.4 million in Q2 and $39.2 million in the first half, compared with $9.4 million and $17.0 million, respectively, in 2019. The first-half total included $22.1 million of employee termination charges and $4.2 million of impairment charges.
- On June 29, Quad amended its senior secured credit facility: financial covenant relief runs through September 30, 2021; the revolver commitment was reduced from $800 million to $500 million; pricing terms were adjusted, including a 0.75% LIBOR floor; and dividends and share repurchases are prohibited during the relief period. Quad stated it was in compliance with financial covenants at June 30.
- The quarterly dividend was suspended beginning in Q2, and the credit amendment prohibits dividends and stock repurchases during the covenant relief period. Management said it intends to seek to resume dividends after operating conditions stabilize and the relief period ends.
- Quad increased its ownership of Rise Interactive from 57% to 99% on June 15 through equity purchases funded partly by a $15.9 million note payable and cash. The Versailles book plant was sold July 1 for $7.9 million cash plus assumption of approximately $3.0 million in finance lease obligations; proceeds were used to reduce debt.
- First-half discontinued-operations loss was $12.5 million, versus $21.7 million. Q2 discontinued-operations loss was $8.7 million, including $10.0 million of impairment charges on Book business property and equipment. The filing reports $61.6 million of Book business sales for the first half.
Outlook, risks and contingencies
- No specific revenue, earnings or cash-flow guidance is provided. Management says the pandemic’s effects on demand, operations, cash flows and the supply chain remain uncertain; 2020 seasonality may also be affected.
- Management said current liquidity and cash-preservation measures were sufficient for ongoing operations and debt and pension requirements, while acknowledging covenant compliance cannot be assured in future periods. The company’s 3.18x net-of-excess-cash leverage ratio was above its stated 2.0x–2.5x target range, and management expected to operate above that range amid COVID-19 impacts.
- Key business risks include continued print-volume declines, digital substitution, excess industry capacity and price pressure, postal rate or service changes, client credit deterioration, input costs, and the ability to reduce costs. The allowance for credit losses was $36.7 million at June 30, up from $25.0 million at year-end; first-half credit-loss expense was $6.0 million.
- Other obligations include $38.9 million of multiemployer pension withdrawal liabilities and $40.1 million of unrecognized tax benefits. Management said ordinary-course litigation and environmental matters were not expected to materially affect the financial statements.
Important facts for investors to verify
- Whether sales volumes, pricing and service demand recover as pandemic effects evolve, and how much of the decline reflects pass-through paper sales and divestitures.
- Liquidity available under the amended facility, covenant headroom and compliance as performance and EBITDA change; note the $434.8 million covenant-adjusted liquidity figure.
- Progress and cash costs of restructuring, facility closures and the Book business divestiture, including final sale adjustments and remaining obligations.
- Whether cash generation can support debt reduction and pension obligations while dividends and buybacks remain restricted.
- Changes in client credit losses, unrecognized tax benefits, and other contingencies or estimates that could affect future results.