Quad/Graphics, Inc. (QUAD) Q3 2014 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Quad/Graphics Third Quarter 2014 Conference Call. [Operator Instructions] I would now turn the conference over to Mr. Kelly Vanderboom, Vice President and Treasurer for Quad/Graphics. Kelly, please go ahead.

Thank you, operator, and good morning, everyone. With me today are Joel Quadracci, our Chairman, President and Chief Executive Officer; and Dave Honan, Vice President and Chief Financial Officer. Joel will lead off today with key highlights for the quarter and Dave will follow with a more detailed review of our financial results followed by Q&A. I would like to remind everyone that this call is being webcast, and forward-looking statements are subject to safe harbor provisions as outlined in our quarterly news release and in today's slide presentation. Our financial results are prepared in accordance with generally accepted accounting principles. However, this presentation also contains non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, free cash flow and debt leverage ratio. We have included in the slide presentation reconciliations of these non-GAAP financial measures to GAAP financial measures. The slide presentation can be accessed through a link on the Investor Relations section of Quad/Graphics' website. There are also instructions on how to access the slide presentation in our third quarter earnings news release issued last evening. A replay of the call will also be posted on the Investor Relations section of our website after today's call. I'll now turn the call over to Joel.

Thanks, Kelly, and good morning, everyone. Our performance for the third quarter was in line with our expectations and we remain on track to achieve our 2014 financial objectives. We continue to move forward swiftly with integrating operations from the Brown acquisition, putting a strong focus on serving our clients well while improving the efficiency and productivity of our platform to drive future cost savings. We remain confident in our integration process and I'm pleased to report our integration efforts are going well. During the quarter, we completed the 2 previously announced plant closures of former Brown facility in Woodstock, Illinois and a former Worldcolor plant in St. Cloud, Minnesota. Through these closures, we further rationalized capacity and consolidated work into plants where we believe we can achieve the greatest manufacturing and distribution efficiencies. I am proud of the work our employees are doing to advance the integration quickly and achieve our objectives. During the quarter, volumes in our U.S. platform were in line with our expectations and our corporate units performed well. We continue to extend and expand work with existing clients, as well as win work from new clients. Taking a consultative approach, we create value for our clients by showing them how to minimize their overall total cost of print production and distribution, while at the same time, how to maximize their revenue by connecting print to other channels, such as mobile and tablet. Our mailing and distribution solutions are a big part of how we help our clients reduce costs and get the most value for every dollar they invest in print. We have built a leading platform with scale and volumes second to none in the industry and we believe this platform will give us a long-term sustainable advantage versus our competition. Our platform is complemented by dedicated postal solutions experts who consult with clients early in the printing planning process to understand their business goals and help them get the most value in cost savings with every mail piece. This includes co-mailing magazines and catalogs and commingling letter-size direct mail. Through co-mailing and commingling, we combine multiple clients' mail pieces into a single mail stream sorted and bundled in carry route order. The U.S. Postal Service awards discounts for this type of sorting and bundling because it requires less handling throughout its system. We continue to invest in additional co-mail capacity to extend our leadership position in the industry and to ensure the greatest number of clients are able to participate in re-cost savings. Through the first 9 months of the year, we have co-mailed approximately 4 billion magazines, catalogs and direct mail pieces, representing a 5% organic increase over 2013. This increase does not include volumes from the Brown acquisition, which we are in the process of incorporating into our platform. We continue to strengthen our offerings through ongoing investments in higher growth print categories, such as in-store signage and displays, commercial and specialty print and packaging. These print categories are valued by new and existing clients. For example, our in-store Marketing Solutions Group, known as Tempt In-Store Productions, is a valuable resource for our retail clients. Tempt helps retailers and brand marketers of all kinds to create dynamic, engaging in-store marketing displays and programs that can include interactive elements. Tempt's North American design center features a dedicated prototyping zone where clients can develop and test ideas to drive increased shopper engagement and revenue. Recently, Tempt installed a new 81-inch press, the largest of its kind, that will increase options for retailers looking to push the boundaries of shopper engagement. Our investment in Tempt underscores our commitment to offering the widest possible range of global solutions for the retail industry. Our solutions include unique and powerful ways to design, produce and deliver retail promotions through long-run and targeted ad inserts. Catalogs, direct mail and custom products, mobile activated print campaigns and videos with content optimized for searchability online and through YouTube. All of our solutions promote a consistent brand experience from store to web and mobile to drive more traffic and revenue. Outside of print, we continue to grow QuadMed, a nationally recognized provider of on-site and shared site and corporate sponsored [ph] health and wellness solutions. QuadMed now provides healthcare management solutions to Fortune 500 companies, including Huntington Ingalls Industries, one of the largest shipbuilders for the U.S. Navy and Coast Guard. Huntington Ingalls recently contracted with us to build and manage 2 employee health centers: 1 in Virginia where they employ 23,000 employees; and 1 in Mississippi where they employ 11,000 employees. We're excited about this opportunity to partner with such a large premier employer. Coast-to-coast, QuadMed now manage more than 100 clinical patients, including those that operates for Quad/Graphics. So beyond the value QuadMed provides to the marketplace, it also brings tremendous cost savings to our own company. Through QuadMed, we've been able to significantly reduce our own company's healthcare-related costs, which goes a long way toward helping us maintain our status as low-cost producer in the industry. QuadMed's revolutionary approach focuses on keeping people well through robust disease prevention and other wellness programs. As such, QuadMed is a win-win for employees and our company and greatly contributes to our efforts in attracting and retaining talent. Before I turn the call over to Dave, I want to reiterate that we remain confident in our future and as always, we will continue to focus on our goals to transform our company in the industry, improve our clients' experience with us each and every day, maximize our operational and technological excellence to achieve productivity improvements and power engage and develop our employees and enhance our financial strength while creating share value. With that, I will now turn the call over to Dave.

Thanks, Joel, and good morning, everyone. Slide 5 is a snapshot of our third quarter 2014 financial results, as compared to our third quarter in 2013. The acquisition of Brown is included in our 2014 consolidated financial results since the date of acquisition on May 30 of 2014. Accordingly, our 2013 results do not include the acquisition of Brown. Net sales in the third quarter were $1.2 billion, representing a 2.5% increase from 2013, primarily due to the Brown acquisition. If we look at the Brown business on a pro forma basis as if we acquired Brown at the beginning of 2013 instead of on our acquisition date of May 30, 2014, our pro forma consolidated net sales declined 5.6% in the third quarter, of which we estimate Brown represented 1/3 of that decline or approximately 2% of the decline. The remaining 2/3 of the decline or 3.6% reflects the impact of expected volume and pricing pressures and were consistent with our revenue expectations and guidance. Our adjusted EBITDA was $151 million as compared to $154 million in 2013 and our adjusted EBITDA margin was 12.2% as compared to 12.8%, reflecting ongoing pricing and volume pressures and the margin dilution impact of Brown's historically lower margin profile. Year-to-date, free cash flow was in line with our expectations. We define free cash flow as net cash provided by operating activities, including pension contributions, less purchases of property, plants and equipment. Free cash flow was a negative $38 million for the first 9 months of 2014 versus a positive $102 million for the same period in 2013. The variance is primarily due to an estimated $77 million benefit realized in the first 9 months of 2013 related to our acquisition of Vertis, which was acquired without normalized levels of accounts payable and accrued liabilities. The decrease is also attributable to an increase in receivables and inventory during our seasonal peak for working capital, which will decline during the fourth quarter. We realized our strongest volumes in the back half of the year due to seasonality, and as a result, our free cash flow will primarily be generated in the fourth quarter of the year. Annual guidance for free cash flow remains unchanged at a range of $155 million to $165 million. On Slide 7, you will see that our interest coverage ratio is 6.4x at September 30 versus 6.7x at December 31. Our quarter end debt leverage ratio increased to 2.81x at September 30 as a result of a $215 million increase in debt to fund acquisitions and strategic investments, such as Brown and UniGraphic, seasonal working capital needs and capital expenditures. We continue to believe that operating in the 2 to 2.5x leverage range is the appropriate target over the long term but we may, at times like now, operate outside of this range depending on the timing of compelling strategic investment opportunities and seasonal working capital needs. Quad continues to be a significant annual free cash flow generator. The Brown acquisition will further contribute to our cash generation after expending the initial upfront integration costs and consistent with our past consolidating acquisitions like Worldcolor and Vertis, will help deleverage our balance sheet over the long term. Since the close of the Worldcolor acquisition on July 2, 2010, we've reduced debt by $172 million. As it relates to our pension, postretirement and multiemployer pension liabilities, we continue to make progress in reducing the underfunded liability that was acquired in part of the Worldcolor acquisition. We have reduced that underfunded liability by $407 million and have a remaining unfunded liability of $140 million as of September 30. Slide 8 includes a summary of our debt capital structure. We recently completed the repurchase of $109 million of fixed rate private notes under our master note and security agreement. This transaction replaced 7.5% fixed rate debt with 2.2% floating rate debt and will lead to net interest expense savings in the fourth quarter of approximately $1.5 million and approximately $5 million of savings in 2015 at current LIBOR rates. From a pro forma perspective, after giving effect to the $109 million private note repurchase, availability under our revolver is $576 million at September 30, and we have no significant debt maturities until April 2019. The weighted average duration under our debt capital structure is 5.5 years with a blended interest rate of 4.7%. Our fixed-rate debt is at an average interest rate of 7.2% and our floating rate debt is at an average interest rate of 3.1%. Our debt capital structure is now 60% floating and 40% fixed. We believe this fixed versus floating rate debt structure will provide us with the financial flexibility we need over the long term. Given the flexibility under our revolver, we have sufficient liquidity and financial strength to support our capital deployment strategy. We remain flexible and opportunistic in terms of our future plans for capital deployment, which includes balancing our key priorities to pay down debt and pension liabilities, invest in our business, pursue future growth opportunities and return value to our shareholders. One key way in which we return value to our shareholders is through our quarterly dividend. Our next quarterly dividend of $0.30 per share will be payable on December 19, 2014, to shareholders of record as of December 8, 2014. Finally, as Joel discussed previously, we remain on track to achieve our 2014 financial objectives. As such, our financial guidance remains unchanged for 2014. I would now like to turn the call back to our operator, who will facilitate taking your questions. Operator?

[Operator Instructions] And your first question is from John Leonard.

Great quarter. The last call, you sounded optimistic going into the seasonally stronger back half of the year. I was just wondering if you think that there's maybe even scope for an incremental upside surprise given the more constructive macro backdrop that we've seen with the improving employment picture and lower oil price that could lead to higher retail sales or spending. So if you have any color on that, that'd be great.

Okay, John, before I have Dave answer that, I just want to let everyone know that we were informed by our provider for the conference call that we did have some technical glitches with the slides in the web portion so we apologize for that, we will rectify that and have them posted. But with that, Dave, why don't you answer the question.

Yes, John. Just kind of to reiterate, every quarter and so far this year really has come in line with what we had expected. So really, right now, we feel good about the guidance going into the fourth quarter and the inferred midpoint that reflects as you go through the calculation. We gave a fairly tight range to begin the year with and we haven't changed that throughout. And so that leads us into the fourth quarter and the fourth quarter is a very big quarter for us in terms of volumes, EBITDA and especially free cash flow delivery. So right now we feel good going into it but our focus is really going to be on the finish this year well and deliver the results we guided to originally.

And that being said, furthermore, when you look at the fourth quarter, I'd say one of the toughest quarters to see or toughest months to see is actually December because we tend to get a little bit later guidance in terms of what the volumes of our customers will be as they try and assess the season and sort of look forward to 2015. And obviously, there's a lot of dynamics playing out, I think, in the world today. So I think Dave's exactly right. I mean we feel good about the range that we've given and we're going to manage to the best of our abilities depending on where things go.

I'm showing that we have no further questions at this time.

Wow, you guys are easy this quarter. So no further questions. I do want to sort of take a moment to thank all of our employees. I'd like to close this call by recognizing our employees, all of whom have been working really hard attending to the needs of our clients right now. And I want to thank them for the exceptional job they're doing integrating Brown's operations with our own while in the midst of our busiest time of the year. So with that, I will close the call and look forward to speaking to you all next quarter. Thank you.

This does conclude today's conference. You may now disconnect.