Quad/Graphics, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Quad/Graphics provides commercial printing and related services. Comparisons with 2010 are materially affected by the July 2, 2010 acquisition of World Color Press; its results are included in Quad’s consolidated results only from that date.
Financial results and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $1,070.5 million, versus $394.3 million in 2010 | $2,172.8 million, versus $797.9 million in 2010 |
| Operating income (loss) | $15.4 million, versus $(23.7) million | $30.0 million, versus $(19.7) million |
| Net loss attributable to common shareholders | $(10.3) million; $(0.22) per share, versus $(35.7) million; $(1.27) per share | $(17.6) million; $(0.37) per share, versus $(44.2) million; $(1.57) per share |
| EBITDA and EBITDA margin | $103.3 million; 9.6%, versus $26.0 million; 6.6% | $209.2 million; 9.6%, versus $82.0 million; 10.3% |
| Operating cash flow | $116.7 million for the six months, versus $74.3 million in 2010 |
EBITDA is a company-defined non-GAAP measure; reported sales and EBITDA comparisons reflect the acquisition and should not be read as organic growth. On a pro forma combined basis, sales were $1,070.5 million for Q2 2011 versus $1,075.3 million in Q2 2010, and $2,172.8 million for the first half versus $2,170.9 million. Pro forma common-shareholder net losses were $10.3 million and $17.6 million, respectively, compared with $5.3 million and $23.1 million in the corresponding 2010 periods.
Q2 operating margin was 1.4%, compared with negative 6.0% a year earlier; first-half operating margin was 1.4%, compared with negative 2.5%. First-half EBITDA margin declined from 10.3% to 9.6%, which management attributed primarily to increased restructuring, impairment and transaction-related costs. Interest expense rose to $29.5 million in Q2 and $59.4 million in the first half, reflecting higher debt following the acquisition. Income tax benefits were $3.6 million and $10.8 million, respectively.
At June 30, 2011, cash and cash equivalents were $16.6 million; current assets were $1,153.2 million and current liabilities $790.5 million. Total debt was $1,513.0 million, including $88.1 million classified as current; capital lease obligations totaled $48.9 million. Debt was approximately $1,521.0 million at December 31, 2010. The company reported compliance with its then-existing debt covenants, including a 2.39x leverage ratio against a 3.75x maximum.
Material changes and management commentary
- The acquisition drove most of the sharp reported year-over-year sales increase. Management also cited higher paper and byproduct sales, increased legacy-customer volumes and favorable foreign exchange, partly offset by pricing pressure from industry overcapacity.
- Management said integration synergies supported operating improvement, but were partly offset by weaker labor productivity during plant consolidation, higher energy and commodity costs, and pricing pressure. First-half restructuring, impairment and transaction-related charges were $58.2 million, including $20.2 million of termination costs, $16.1 million of integration costs and $20.9 million of other restructuring charges. No impairment charges were recorded in the first half of 2011.
- Management estimated World Color Press synergy savings of more than $225 million and integration-related costs of $195 million to $240 million. It cautioned that savings may not be fully realized and costs may exceed estimates. The company announced closures of the St. Laurent, Mt. Morris and Buffalo plants during 2011 and expected additional restructuring charges.
- Operating cash flow increased by $42.4 million year over year, primarily because of the lower net loss, partly offset by higher working capital, pension and postretirement contributions, and income tax payments. Capital expenditures were $98.5 million for the first half. Management planned $170 million to $200 million of capital projects for 2011.
- On July 26, 2011, Quad refinanced its prior $1.23 billion financing agreement with a $1.5 billion facility: an $850 million revolver, $450 million Term Loan A and $200 million Term Loan B. Management expected annual cash interest savings of $16 million to $20 million at then-current borrowing levels and greater revolving capacity. The new agreement is secured by substantially all unencumbered assets and includes financial covenants and restrictions on certain payments.
- On July 12, 2011, Quad agreed to acquire Transcontinental’s Mexican operations and certain U.S.-export book printing business, while selling most of its Canadian operations to Transcontinental. The transactions were subject to regulatory approvals that were not complete as of August 11, 2011.
Outlook, risks and contingencies
No formal earnings guidance is stated in the filing. Management expected the business’s typical seasonality to continue: sales and operating income are generally higher in the second half, particularly around back-to-school and holiday advertising. It cautioned that first-half results are not a reliable predictor of full-year 2011 results.
Key risks include commercial-printing overcapacity and price competition; potential declines in print demand from electronic and mobile media; execution of acquisition integration and synergy plans; labor productivity during consolidation; paper, energy, fuel and freight costs; interest and foreign exchange movements; and macroeconomic, political and regulatory conditions. The company also disclosed customer credit risk, though its largest customer represented less than 5% of sales in the periods reported.
Commitments included $38.7 million for press and finishing equipment purchases. Management did not expect ordinary-course litigation or environmental matters to have a material adverse effect, but noted that final allowed World Color Press bankruptcy claims are uncertain: priority cash claims could exceed the $23.3 million liability recorded, and unsecured notes could reach $75 million in principal. Restricted cash held for those unsecured claims was $81.2 million at June 30.
Investor facts to verify
- Whether the stated synergy target is achieved and integration costs remain within management’s estimated range.
- Progress and final terms, timing and regulatory approval of the Transcontinental transactions.
- Debt reduction, interest savings, covenant headroom and the effect of the new secured financing.
- Whether pricing, labor productivity and input-cost pressures affect operating margins as integration continues.
- Resolution of bankruptcy claims and any resulting additional cash payments, liabilities or expense.
- Capital spending against the $170 million to $200 million 2011 plan, and the sustainability of operating cash flow and dividends.