Quad/Graphics, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Unaudited results; amounts in U.S. dollars. Quad provides print, logistics, imaging and marketing services through its U.S. Print and Related Services and International segments.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $943.6 million | $973.5 million | $2,853.5 million | $2,860.9 million |
| Operating income (loss), continuing operations | ($29.4) million | $47.0 million | $5.7 million | $85.2 million |
| Net income (loss), continuing operations | ($47.0) million | $27.5 million | ($62.8) million | $41.1 million |
| Net income (loss) attributable to Quad shareholders, including discontinued operations | ($126.5) million | $23.4 million | ($163.8) million | $29.3 million |
| Diluted EPS, total | ($2.52) | $0.46 | ($3.28) | $0.57 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $4.1 million | $46.6 million |
- Q3 sales fell 3.1%; product sales declined 3.7%, while services declined 0.6%. Nine-month sales were nearly flat: products declined 1.4%, partly offset by 4.3% growth in services.
- Gross profit was approximately $179.1 million in Q3 (19.0% of sales), versus $196.5 million (20.2%) a year earlier. For nine months, it was $529.2 million (18.6%), versus $556.6 million (19.5%).
- Q3 continuing-operations operating margin was negative 3.1%, versus positive 4.8%; nine-month margin was 0.2%, versus 3.0%. Q3 non-GAAP EBITDA was negative $69.9 million (negative 7.4% margin); nine-month EBITDA was $37.1 million (1.3%), compared with $245.4 million (8.6%) in 2018. EBITDA includes discontinued operations and company-defined adjustments are non-GAAP.
- Management attributed weaker continuing results principally to print volume and pricing pressure, higher production wages, lower paper byproduct recoveries, and increased SG&A. Cost-reduction savings and acquired marketing-services earnings partially offset these pressures.
Liquidity, debt and cash flow
- At September 30, cash was $18.2 million, down from $69.5 million at December 31, 2018. Current assets were $865.0 million and current liabilities $818.9 million.
- Total debt was $1.165 billion, up from $925.5 million at year-end; finance lease obligations added $13.3 million. Debt and finance lease obligations totaled $1.178 billion. Interest expense was $22.0 million for Q3 and $69.6 million for nine months.
- Nine-month operating cash flow was $4.1 million; capital expenditures were $98.5 million. Quad’s non-GAAP free cash flow was negative $34.6 million, including an add-back of $59.8 million in LSC-related payments; it was negative $38.4 million in 2018.
- Quad reported $748.1 million of unused revolving-credit capacity, net of letters of credit. Its non-GAAP debt leverage ratio was 3.27x, up from 2.17x at December 2018; management’s stated target range was 2.0x–2.5x. The company was in compliance with debt covenants: total leverage was 3.18x against a 3.75x limit, and interest coverage was 4.85x against a 3.00x minimum.
Material changes, outlook and risks
- Quad decided to sell its U.S. Book business and classified it as discontinued operations and held for sale. Q3 and nine-month after-tax losses from discontinued operations were $79.4 million and $101.1 million, respectively. The period included $85.0 million of property, plant and equipment impairment, $5.6 million of contract-asset impairment and $10.1 million of goodwill impairment.
- Quad acquired creative agency Periscope in January for $121.0 million cash paid. The acquisition supports its strategy to expand integrated marketing services.
- The proposed LSC Communications acquisition was terminated. Quad recorded a $45.0 million reverse termination fee and a $30.5 million nine-month loss on debt extinguishment, and incurred additional transaction and financing costs.
- Quad said it expects seasonal sales and operating income to be higher in Q3 and Q4 than in the first half, with Q4 typically producing the strongest operating cash flow as working capital declines. No specific full-year financial guidance is provided in the supplied filing text. Management expects further restructuring and integration charges.
- Risks include secular declines and pricing pressure in print, industry overcapacity, postal-rate and service changes, raw-material and labor costs, acquisition integration, customer renewals and contract performance, international currency and compliance exposure, and debt-covenant constraints. The filing reports a $9.9 million SEC payment in October 2019 resolving FCPA-related matters; DOJ declined action. Quad also agreed to pay $3.2 million to Peru’s INDECOPI over four years beginning January 2020.
- On October 29, 2019, Quad declared a quarterly dividend of $0.15 per share, below the $0.30 per share paid in each of the first three quarters of 2019.
Investor verification priorities
- Review the proposed Book-business sale, its expected timing and proceeds, and whether further impairments or operating losses may arise.
- Assess cash generation and working-capital seasonality against the low cash balance, capital spending, debt service and dividend commitments.
- Track leverage against covenant thresholds and management’s target range, including refinancing needs ahead of the May 2022 senior-note maturity.
- Separate recurring operating performance from the LSC termination, debt-extinguishment costs, discontinued-operation impairments and restructuring charges.
- Verify whether acquired marketing-services businesses can offset continuing print-volume and pricing declines and improve margins.