Quad/Graphics, Inc. — Q2 2017 Form 10-Q
Business context and period. Quad is a commercial printing and marketing-services provider, with United States Print and Related Services and International segments. This unaudited report covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. Results are seasonal, typically stronger in the third and fourth quarters.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $963.2m | $1,032.3m | $1,961.8m | $2,074.8m |
| Operating income | $32.7m | $13.3m | $86.3m | $26.3m |
| Operating margin | 3.4% | 1.3% | 4.4% | 1.3% |
| Net earnings (loss) | $6.7m | $(7.7)m | $32.1m | $(3.9)m |
| Diluted EPS | $0.13 | $(0.16) | $0.62 | $(0.08) |
| EBITDA and margin (non-GAAP) | $91.1m; 9.5% | $89.5m; 8.7% | $200.1m; 10.2% | $193.8m; 9.3% |
- Sales declined 6.7% in Q2 and 5.4% year to date. Product sales fell 7.7% and 6.2%, respectively, mainly from lower print volume and pricing, pass-through paper sales, and, internationally, currency effects. Services sales were down 0.8% and 0.7%.
- Operating income improved despite lower sales, supported by lower depreciation and amortization, cost reductions, and lower restructuring charges. Q2 results included a $5.0m property-insurance gain; first-half results also benefited from a $17.4m vacation-reserve reduction, $6.3m lower legal costs, and favorable currency impacts. These items temper comparisons of underlying performance.
- Cash flow: First-half operating cash flow was $112.2m versus $219.6m; capital spending was $42.8m versus $40.6m, producing free cash flow (non-GAAP) of $69.4m versus $179.0m. The operating-cash-flow decline primarily reflected a smaller working-capital benefit and reduced employee-related liabilities. Cash and cash equivalents were $8.7m at June 30.
- Debt and liquidity: Total debt was $1,055.0m, with $986.4m long-term; debt and capital lease obligations totaled $1,077.8m. The reported Debt Leverage Ratio (non-GAAP) was 2.25x, down from 2.36x at year-end 2016. The company reported $682.2m of unused revolving capacity, net of letters of credit, and was in compliance with financial covenants. Current assets were $825.4m and current liabilities $671.7m.
- Margins and segments: U.S. Print and Related Services posted Q2 operating income of $40.7m on sales of $872.3m (4.7% margin); International reported $3.3m on $90.9m (3.6% margin), versus a year-earlier operating loss. International sales remained pressured.
- Dividends declared were $0.30 per share in each quarter; a further $0.30 quarterly dividend was declared August 1, payable September 1, 2017.
Changes, outlook, and risks
- In February 2017, Quad amended its senior secured credit facility, reducing the revolving facility to $725m and Term Loan A to $375m, and extending their maturities to January 2021. A $250m interest-rate swap fixes the rate on that portion of variable-rate debt at 3.89% including the debt spread; the swap matures in February 2022.
- Management said it expects adequate operating cash flow and revolver capacity to fund operations, restructuring, capital expenditures, debt and pension obligations, investments, and shareholder returns. The filing gives no specific earnings or revenue guidance. Management expects additional restructuring charges and says seasonal patterns are expected to continue.
- Key business risks include declining print demand and industry overcapacity, pricing pressure, digital substitution, client contract and renewal risk, labor and raw-material costs, postal-service changes, and international and currency risks. Management also cautions that covenant compliance cannot be assured in future periods.
- The company is cooperating with the SEC and DOJ on self-reported potential Foreign Corrupt Practices Act issues involving operations managed from Peru and certain China transactions. Management did not anticipate a material adverse business or financial effect at the filing date.
- Quad has a $40.8m reserve for multiemployer pension withdrawal liabilities. The GCIU liability remains in litigation, and the estimate may change. Remaining bankruptcy claims also could require payments above accrued estimates.
- Revenue recognition standard adoption was planned for Q1 2018. The company was assessing whether some contracts qualify for recognition over time rather than at a point in time, which could significantly affect adoption-period financial statements and systems.
Most important facts for investors to verify
- Whether print-volume and pricing declines continue, and whether cost savings can offset them without relying on nonrecurring benefits or lower amortization.
- The sustainability of operating cash flow and free cash flow after the marked first-half decline, including seasonal working-capital requirements.
- Debt reduction, revolver availability, covenant headroom, and the impact of variable interest rates.
- Developments and potential costs from the SEC/DOJ investigation, GCIU pension litigation, and unresolved bankruptcy claims.
- The final revenue-recognition assessment and the effect of the expected 2018 adoption.