Quad/Graphics, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Quad provides print products and related services, logistics, and integrated marketing services through its U.S. Print and Related Services and International segments. Results are seasonal, with sales and operating income typically higher in the third and fourth quarters.
Financial results and liquidity
Amounts are in millions of dollars, except per-share data and ratios.
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $1,004.7 | $967.5 |
| Operating income | $2.9 | $7.1 |
| Operating margin | 0.3% | 0.7% |
| EBITDA (non-GAAP) | $47.9 | $66.7 |
| EBITDA margin (non-GAAP) | 4.8% | 6.9% |
| Net loss attributable to Quad common shareholders | $(22.5) | $(3.5) |
| Diluted loss per share | $(0.45) | $(0.07) |
| Net cash from (used in) operating activities | $(58.6) | $2.2 |
| Free cash flow (non-GAAP) | $(100.6) | $(22.0) |
- Revenue mix and growth: Sales rose 3.8%. Product sales increased 0.5%, including higher pass-through paper sales, while print product-line sales faced volume and pricing pressure. Services grew 20.0%, primarily reflecting the Ivie and Periscope acquisitions and consolidation of Rise; print management and imaging services declined.
- Cash flow and investment: Operating cash flow fell $60.8 million year over year, which management attributed mainly to working-capital changes, particularly lower accounts payable, and lower cash from earnings. Capital expenditures were $45.3 million, versus $24.2 million. Business acquisitions used $121.0 million; investing cash outflow was $158.2 million.
- Cash and liquidity: Cash was $10.4 million at quarter-end, down from $69.5 million at December 31, 2018. Quad reported $515.6 million of unused revolving-credit capacity, net of letters of credit, and said expected cash flows, available cash, and revolver capacity should fund operations, integration, capital spending, debt service, and shareholder returns.
- Debt and leverage: Total debt was $1,126.9 million, compared with $925.5 million at year-end; debt plus finance leases was $1,141.8 million. The company’s non-GAAP Debt Leverage Ratio rose to 2.99x from 2.25x, above management’s stated 2.0x–2.5x target range. Covenant total leverage was 2.90x against a 3.75x maximum; senior secured leverage was 2.26x against a 3.50x maximum; interest coverage was 5.38x against a 3.00x minimum. Quad reported compliance with its financial covenants at March 31.
- Margins and segment performance: U.S. Print and Related Services operating income was $15.8 million, down from $20.3 million, and margin was 1.8% versus 2.3%. International operating income was $1.9 million, down from $5.7 million, with margin of 1.8% versus 5.7%.
- Other balance-sheet items: Total assets were $2,603.2 million and shareholders’ equity including noncontrolling interests was $419.9 million. Adoption of the new lease standard added operating lease right-of-use assets and obligations; March 31 operating lease obligations were $130.8 million.
Material changes and unusual items
- Quad acquired creative agency Periscope on January 3 for $121.0 million cash paid. The preliminary purchase-price allocation included $60.2 million of goodwill and $70.5 million of identifiable intangible assets.
- On January 31, Quad amended its senior secured credit facility to expand borrowing capacity and provide flexibility for the proposed LSC acquisition. Refinancing resulted in a $15.9 million debt-extinguishment loss and $20.2 million of debt-issuance costs, some of which were expensed.
- Operating income was pressured by lower print volumes and pricing, and by prior-year benefits from property-insurance gains and employee-vacation-policy changes. Offsetting factors included lower restructuring charges, cost reductions, and earnings from acquired or consolidated businesses. Q1 2018 also included a $22.3 million noncash ESOP contribution that did not recur.
- Restructuring, impairment, and transaction-related charges declined to $7.6 million from $24.9 million. Q1 2019 included $1.7 million of impairment charges and a $3.5 million gain on sale of the Hazleton facility.
Outlook, risks, and contingencies
- LSC transaction: Quad continued to expect its proposed all-stock acquisition of LSC Communications, valued at approximately $1.3 billion including refinancing of LSC debt and assumed obligations, to close in mid-2019. The deal remained subject to regulatory approvals and other closing conditions. The DOJ had issued a Second Request for information, extending the HSR waiting period. Quad cited expected synergies from eliminating duplicative functions, rationalizing capacity, and improving operations and supply-chain efficiency.
- Management commentary: Quad is pursuing its “Quad 3.0” strategy to expand integrated marketing services while streamlining and consolidating print operations. It expects continued seasonality and stated that additional restructuring and integration costs are expected. No specific earnings or revenue guidance is provided in the supplied filing text.
- Industry and operating risks: The filing highlights declining print demand, digital substitution, excess printing capacity and pricing pressure, labor and raw-material costs, postal-rate and service changes, customer contract and credit risks, and the challenge of integrating acquisitions. Management also notes that significant capital investment may be needed to remain competitive.
- Legal and regulatory matters: Quad reported ongoing cooperation with the SEC, DOJ, OFAC, and Peru’s INDECOPI regarding previously self-reported FCPA-related issues in Peru, transactions involving Quad/Tech China, Cuba-related transactions, and an antitrust investigation in Peru. Management did not anticipate a material adverse effect on business or financial condition, but outcomes remain uncertain. Routine litigation was not expected to have a material impact.
- Other obligations and returns: Quad had $49.2 million reserved for multiemployer pension-plan withdrawal liabilities. It declared a $0.30-per-share quarterly dividend in April, payable in June. The company reported no open foreign-exchange contracts at quarter-end and noted Argentina’s highly inflationary status, with $1.1 million of foreign-currency losses in the quarter.
Important facts for investors to verify
- Progress, regulatory clearance, financing, closing conditions, and integration economics for the proposed LSC acquisition.
- Whether operating cash flow improves as working capital normalizes, given negative Q1 free cash flow and only $10.4 million of quarter-end cash.
- Debt reduction and leverage trajectory relative to management’s 2.0x–2.5x target and applicable credit-agreement covenants.
- Whether service growth and acquisitions can offset ongoing print-volume, pricing, and margin pressure, particularly in the International segment.
- Potential costs or consequences from restructuring, pension withdrawal liabilities, and the disclosed regulatory investigations.
- Dividend sustainability and any capital-allocation limits: the filing states the total-leverage-based restriction on annual dividends, repurchases, and certain payments was applicable at quarter-end.