Quad/Graphics, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Quad/Graphics provides printing, marketing and related services, primarily through its United States Print and Related Services segment, which generated about 90% of sales.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,005.4 million | $1,056.4 million | $2,967.2 million | $3,131.2 million |
| Operating income | $49.4 million | $33.8 million | $135.7 million | $60.1 million |
| Operating margin | 4.9% | 3.2% | 4.6% | 1.9% |
| Net earnings | $19.8 million | $11.3 million | $51.9 million | $7.4 million |
| Diluted EPS | $0.38 | $0.22 | $1.01 | $0.15 |
| EBITDA and margin (non-GAAP) | $107.7 million; 10.7% | $95.5 million; 9.0% | $307.8 million; 10.4% | $289.3 million; 9.2% |
Q3 sales fell 4.8% year over year; nine-month sales fell 5.2%. Declines primarily reflected lower print volume and pricing amid industry pressure, along with reduced pass-through paper sales. The nine-month operating income increase included lower restructuring charges and depreciation and amortization, cost savings, a vacation-reserve reduction and a property-insurance gain; it should not be read as solely reflecting improved underlying demand.
Cash flow and capital spending: Nine-month operating cash flow was $179.7 million, down from $260.0 million. Capital expenditures were $61.6 million, producing reported free cash flow (non-GAAP) of $118.1 million, versus $202.3 million. Management attributed weaker operating cash flow mainly to changes in operating assets and liabilities, including lower employee-related liabilities and a smaller working-capital benefit.
Debt and liquidity: Total debt was $1.033 billion at September 30, down from $1.105 billion at year-end 2016; debt and capital lease obligations totaled $1.054 billion. Cash was $15.4 million. The company reported $686.1 million of unused revolving-credit capacity, with no revolver balance at quarter-end. Its non-GAAP Debt Leverage Ratio was 2.22x, within management’s stated 2.0x–2.5x target range. It reported compliance with debt covenants; covenant total leverage was 2.18x versus a 3.75x maximum, and interest coverage was 7.19x versus a 3.50x minimum.
Cash dividends were $0.30 per share in Q3; the company declared another $0.30 quarterly dividend for payment December 1, 2017. It repurchased 200,605 Class A shares for $3.8 million during the quarter.
Material changes and unusual items
- Q3 operating income rose $15.6 million despite lower sales. The filing attributes the increase chiefly to $18.1 million less in restructuring, impairment and transaction-related charges. Excluding those charges, operating income decreased $2.5 million, primarily from lower print volume and pricing, partly offset by cost savings and lower depreciation and amortization.
- For the nine months, restructuring, impairment and transaction-related charges were $22.5 million versus $62.4 million a year earlier. The prior-year period included significant impairment and pension-related charges. The 2017 period included $13.2 million of employee termination charges and gains from facility sales and Argentina vendor settlements.
- Debt was refinanced in February 2017, extending the revolving facility and Term Loan A maturities to January 2021; the amendment generated a $2.6 million debt-extinguishment loss. A $250 million interest-rate swap converts a portion of variable-rate debt to a fixed rate of 3.89% through February 2022.
- Seasonality is significant: sales and operating income typically rise in Q3 and Q4, and operating cash flow is usually highest in Q4 as working capital unwinds.
Outlook, commentary and risks
The filing provides no specific numeric earnings or revenue guidance. Management expects continued cost-reduction and restructuring activity and describes capital priorities as debt and pension-liability reduction, selective investment in growth and productivity, and shareholder returns. It expects seasonal patterns to continue.
Management describes a competitive print market with excess capacity, declining print demand, digital substitution and pricing pressure. Other cited risks include client retention and performance, labor, paper and energy costs, postal rates and service levels, international operations, debt covenants and potential asset impairment. The company self-reported potential Foreign Corrupt Practices Act issues involving Peru and certain China transactions, and transactions involving Cuba under U.S. trade sanctions, to relevant authorities; it said it was cooperating and did not anticipate a material adverse effect, while continuing its investigation. Litigation over the company’s multiemployer pension withdrawal liability remains unresolved; the $31.0 million reserve may change depending on the outcome.
The company expects a non-cash pension settlement charge in Q4 2017 related to lump-sum payments. It also planned to adopt the new revenue-recognition standard in Q1 2018 using the modified retrospective method; its assessment was nearing completion, and it expected certain contract revenue to remain recognized at a point in time, consistent with its then-current policy.
Important facts for investors to verify
- Whether print-volume and pricing declines continue, and whether cost savings can offset them without further margin deterioration.
- How much of reported earnings improvement reflects recurring operations versus lower special charges, reduced amortization, reserve changes and other unusual gains.
- Cash generation and working-capital performance, particularly against the seasonal Q4 cash-flow pattern and ongoing pension, restructuring, capital-spending and dividend needs.
- Debt reduction, variable-rate exposure, covenant headroom and the company’s ability to maintain its leverage target.
- Developments in the FCPA and Cuba-related investigations, the GCIU withdrawal-liability litigation, and remaining World Color Press bankruptcy claims.
- The eventual impact of adopting revenue-recognition, lease and other new accounting standards.