Quad/Graphics, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in millions of dollars except per-share data. Quad provides print, logistics, marketing and related services through its United States Print and Related Services and International segments.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,015.5 | $963.2 | $1,983.0 | $1,961.8 |
| Operating income | $20.9 | $30.1 | $28.0 | $81.1 |
| Operating margin | 2.1% | 3.1% | 1.4% | 4.1% |
| Net earnings attributable to common shareholders | $9.4 | $6.7 | $5.9 | $32.1 |
| Diluted EPS | $0.18 | $0.13 | $0.11 | $0.62 |
| EBITDA, company-defined non-GAAP | $82.4 | $91.1 | $149.1 | $200.1 |
| EBITDA margin, company-defined non-GAAP | 8.1% | 9.5% | 7.5% | 10.2% |
- Q2 sales rose 5.4%; service sales increased 47.5%, primarily reflecting Ivie and Rise, while product sales fell 2.0%. For the first half, sales rose 1.1%; product sales declined 4.1% as service sales increased 31.4%.
- Operating cash flow was $40.5 for the first half, down from $112.2. Capital expenditures were $53.8, resulting in negative free cash flow of $13.3, versus positive $69.4 a year earlier. Working-capital changes reduced cash flows by $104.8.
- Cash was $8.9 at June 30, versus $64.4 at year-end 2017. Total debt was $1,030.1; debt and capital lease obligations together were $1,047.8. Unused revolving capacity was $585.0, net of letters of credit.
- The company reported a 2.34x debt leverage ratio under its non-GAAP measure, within its stated 2.0x–2.5x target range. It was in compliance with financial covenants; covenant total leverage was 2.27x against a 3.75x maximum, and interest coverage was 6.87x against a 3.50x minimum.
- Dividends declared were $0.30 per share in each quarter. The company repurchased 1.87 million Class A shares for $36.7 during the first half.
Material changes and notable items
- Q2 operating income fell $9.2 year over year despite higher sales; first-half operating income fell $53.1. Management cited continued print volume and pricing pressure, higher restructuring and impairment charges, and first-half non-cash expense of $22.3 for a special employee retirement contribution. Cost savings and acquired businesses partly offset these effects.
- Q2 net earnings increased year over year despite lower operating income, aided by a $3.7 income tax benefit versus $8.3 tax expense in Q2 2017. First-half net earnings declined to $6.0 from $32.1; the 2018 period also included a $7.0 tax benefit, while 2017 included a $2.6 debt-extinguishment loss.
- Restructuring, impairment and transaction-related charges were $10.4 in Q2 and $35.3 in the first half, versus $5.3 and $14.5, respectively, in 2017. First-half charges included $11.5 of impairments and $13.1 of employee termination costs.
- Quad acquired marketing-services provider Ivie in February and increased its Rise Interactive ownership from 19% to 57% in March, consolidating Rise from that date. These transactions increased service revenue and debt; purchase accounting valuations were preliminary at quarter-end.
- Adoption of revenue standard Topic 606 had no material financial-statement effect. Consolidation of Rise created $18.5 of noncontrolling interests at June 30.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management expects seasonal sales and operating income to be higher in the third and fourth quarters, with fourth-quarter operating cash flow typically strongest as working capital unwinds. Management stated that cash, expected operating cash flows and revolver availability should fund operating needs, integration and restructuring, investment, debt service and shareholder returns.
- Management described persistent industry headwinds: declining print demand, digital substitution, excess printing capacity and pricing pressure. Costs and supply of paper, labor, energy and freight, postal rates and client contract renewals are additional uncertainties.
- Preliminary U.S. duties on certain Canadian uncoated groundwood paper could increase input costs and potentially reduce demand; the filing described the related International Trade Commission review as pending. Changes to postal pricing rules could also raise mailing costs and accelerate substitution away from print.
- The company disclosed ongoing SEC and DOJ investigations following self-reported potential Foreign Corrupt Practices Act issues involving Peru and China, and an OFAC, DOJ and SEC review of transactions involving Cuba. Quad said it was cooperating and did not anticipate a material adverse effect at that time.
- A disputed Graphic Communications International Union multiemployer pension withdrawal demand remains in litigation. Quad reserved $22.8 for multiemployer withdrawal liabilities; the final amount could change with the outcome. Management did not expect ordinary-course lawsuits or environmental matters to have a material effect.
- Other risks include acquisition integration, foreign exchange, interest rates, covenant compliance, and potential asset impairment. Management reported disclosure controls as effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether print volume and pricing pressures continue, and whether growth in marketing services offsets the decline in print.
- Cash conversion and working-capital trends, given the sharp decline in operating cash flow and negative first-half free cash flow.
- Debt, leverage, covenant headroom and liquidity as acquisitions, restructuring and seasonal cash needs progress.
- Integration performance and final purchase accounting for Ivie and Rise, including any earn-out or noncontrolling-interest effects.
- Developments in the paper-duty and postal-rate proceedings, the Peru/China/Cuba investigations, and the GCIU withdrawal-liability litigation.
- Subsequent actions: the board declared a $0.30 quarterly dividend on July 31, 2018, and authorized a new share repurchase program of up to $100 million on July 30, 2018.