Quad/Graphics, Inc. (QUAD) Q1 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Quad/Graphics First Quarter 2015 Conference Call. During today’s call, all participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I will now turn the conference over to Kyle Egan, Quad/Graphics Manager of Investor Relations. Kyle, please go ahead. Okay, Mr. Egan, 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, our Executive Vice President and Chief Financial Officer. Joel will lead off today's call 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 the Investor Relations section of the Quad/Graphics' website under the Events and Recent Presentations link in the left-hand navigation bar. There are also instructions on how to access the slide presentation in our quarterly news release issued last evening. A replay of the call will be available on the Investor Relations section of our website after today's call. I will now turn the call over to Joel.

Thanks, Kyle, and good morning. I am pleased to report that our first quarter results were in line with our expectations and we remain on track to achieve our 2015 financial objectives. As a company we continue to focus on ways to grow market share, improve productivity and implement sustainable cost reduction initiatives while maintaining a strong balance sheet, invest in our business and pursue compelling acquisition opportunities. Slide 3 shows the five primary strategic goals in which we remained focus to transform our company. We believe these goals allow us to be successful despite ongoing industry challenges. Today, I’d like to focus specifically on our strategic goal to grow the business profitably. It’s a transformational time at our company and as always, we remained focused on finding a better way, a matter that is reflected in our brand promise to deliver performance through innovation. While we will continue to capitalize on compelling industry consolidation opportunities, - focused on transformative growth opportunities. One important way we do this is by listening to our clients and adding new products and solutions to help grow their business. For example in the first quarter, we enhanced our in-store marketing solutions offering with the acquisition of Marin’s International, a worldwide leader in point-of-sale display industry with products in more than 100 countries. Packaging is another area of focus for us. We entered into packaging with the 2013 acquisition of Proteus Packaging and last month, we acquired Copac Global Packaging, an international provider of innovative packaging and supply chain solutions headquartered in South Carolina. Further the company strategically sources manufacturing numerous end-markets in Central America and Asia. Proteus and Copac now roll-up under a new brand Quad Packaging. We will continue to make compelling investments designed to drive profitable organic growth and productivity improvements in all our product lines. For example, earlier this year we announced our three year plan to transform our book platform through an investment in 20 or more high-speed color digital web presses. Our plan is already enabling publishers to produce and deliver books faster and more cost-effectively reducing their need to carry large inventories that may go unsold and become obsolete. To-date, we have installed four of the digital color web presses. By mid-June, we will have a total of five presses up and running and anticipate bringing yet another online before year’s end. Regardless of product line or service offerings, our go-to-market strategies are driven by the common purpose to create client value which we do in two essential ways. First, we maximize the revenue of our clients derived from their print spend by helping them connect content across channels for improved performance. And second, we minimize our clients’ overall total cost of print production and distribution. As recently announced, First Magazines takes full advantage of our value creating continuum of services. The vendor of a publisher recently signed a contract with us valued at more than $500 million to print 20 of its 21 magazine titles through the year 2020. In addition, Meredith, one of the largest and most successful magazine publishers in America also has confidence in us as its print partner. It signed a multi-year contract with us to print magazines, specialty catalogs, bookazines and custom publications, and will tap into our direct mail, commercial, signage and other offerings including publisher studio, a comprehensive workflow solution. In addition to these offerings, Meredith signed value in the strength of our co-mail and distribution programs, which creates significant postage savings while also improving delivery times and preserving product quality. Postage continues to be our clients’ single largest manufacturing-related expense accounting for more than 50% of their budget. We continue to invest in our co-mail and distribution capabilities and grow the volumes which drive savings. Last year, we co-mailed approximately 5.3 billion magazines, catalogs, direct marketing pieces, representing an organic growth increase of approximately 5% over 2013. This year, we are incorporating volumes from the Brown Printing acquisition further bolstering volumes and savings opportunities for our clients. As we move forward, we continue to look for ways to make it easier for marketers and publishers to take advantage of our entire continuum of solutions. Everyday we endeavor to be a trusted partner for our clients understanding the challenges unique to their particular industry and helping them navigate the cyclical and secular pressures of today and in the future. We are proud printers innovating all aspects of our business and the industry and we will continue to take the bold steps to manage our costs, build our offering to provide the most powerful solutions to the global marketplace. With that, I will hand over the call to Dave Honan who will provide detailed financial review of the quarter.

Thanks Joel, and good morning everyone. Slide 4 is a snapshot of our first quarter 2015 financial results as compared to the first quarter of 2014. Sales were $1.1 billion in the quarter, consistent with last year and our expectations. Our adjusted EBITDA was $101 million, as compared to $107 million in 2014, and our adjusted EBITDA margin was 9.1%, versus 9.7%. The adjusted EBITDA variance primarily reflects ongoing industry volume and pricing pressures partially offset by additional earnings on sales from recent acquisitions. Also impacting our first quarter adjusted EBITDA were losses in Argentina of approximately $2 million. Declining economic and political conditions in Argentina led us to commence restructuring proceedings there during March. These proceedings were deemed a triggering event for testing our Latin American goodwill for impairments and resulted in a $23 million non-cash goodwill impairment charge. Our hope is that a restructuring plan will improve the financial outlook for our operations in Argentina. With the final results, we’ll be largely dependant on our labor unions and their willingness to work with us on a viable and sustainable business plan to consolidate operations there. Moving to Slide 5, the increase in free cash flow was also in line with our expectations. We define free cash flow as net cash provided by operating activities including pension contribution, less purchases of property plant and equipment. Free Cash Flow was $22 million in the quarter, an increase of $35 million over 2014, primarily to working capital improvements and the receipt of the $10 million acquisition termination fee from Courier Corporation, which was excluded from our adjusted EBITDA as a non-recurring gain. On Slide 6, you will see that we ended the first quarter with just under $1.5 billion of debt and capital leases, an increase of $31 million from December 31, 2014, and at quarter end, debt leverage ratio increased to 2.71 times versus 2.6 times. The increase in total debt and debt leverage ratio is due primarily to increased debt to fund the first quarter 2015 acquisition of Marin’s and lower adjusted EBITDA. We continue to believe that operating in the 2 to 2.5 times leverage range over the long-term is the appropriate target, but we may operate outside this range at times due to compelling investment opportunities, like the Brown and Marin’s acquisitions. We will remain diligent in reducing debt and pension liabilities going forward. In fact, since the close of Worldcolor acquisition on July 2, 2010, we paid down $677 million in debt pension liabilities by March 31 of this year. Slide 7 is a summary of our debt capital structure. Availability under our $815 million revolver was $714 million as of March 31, 2015. We have no significant maturities until April 2019. The weighted average duration under our debt capital structure is 5.2 years with a blended interest rate of 4.9%. 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 56% floating and 44% fixed. We believe this fixed versus floating rate debt structure provides us with the financial flexibility we need over the long term, to balance our key priorities to pay down debt and pension liabilities, invest in our business, pursue future growth opportunities, and return value to our shareholders. Slide 8 shows our commitment to our dividend which is a key way in which we return value to our shareholders. As you can see, we have consistently paid out a quarterly dividend and based on our current stock price, our annual dividend of $1.20 per share is yielding over 5%. Our next quarterly dividend of $0.30 per share will be payable on June 19 to shareholders of record as of June 8, 2015. As we move forward in this challenging industry environment, we continue to be disciplined in how manage all aspects of our business, especially driving improved productivity and sustainable cost reduction initiatives to remain a low-cost provider. We will continue our focus on maintaining a strong and flexible balance sheet to adjust to the changing industry conditions while also investing in our business including compelling acquisition opportunities and returning capital to our shareholders through a robust quarterly dividend. And now I’d like to turn the call back to the operator who facilitates taking your questions. Operator?

[Operator Instructions] The first question comes from Jamie Clement of Macquarie. Go ahead.

Good morning gentlemen.

Hey Jamie, and first things first, I think we recognize there may have been some challenges with the slides as we are going through this. I’ll just remind everybody that the slides were posted last night and should be accessible through our website and the investors’ side. So, with that, Jamie, how are you?

Well, I am doing very well. Thank you very much. Joel, I was wondering, can you give us some insight maybe kind of some trends you are seeing in some of your big product categories, magazines, catalogues inserts, that sort of things?

Yes, in fact, we just had last week, we hosted quite a few C Suites level people, marketing people from all our customers we call CAM Quad. So, the first half of the week was focused on what’s going on in marketing, really multi channel-wise and then the second half of the week was our postal conference, because I usually like to give an update on postal as well. So, all very fresh topics. We’ve seen in the magazine side, it was a slow quarter for ad pages. I think in general in advertising, it was pretty slow along with what we are all discovering is a fairly sluggish underlying economy. And when I look at like catalogues seem to holding up pretty well. I think if you look in your mailbox there is quite a few coming through and we are seeing that with our customers.

Seems like that’s a continuation of second half 2014 trends, sounds like.

Yes, I think that, the consumer spending and it certainly works and remember when you come out of a sort of a cutback period in the catalogue world, it takes a while to build up the rentable names again or fresh names to go to, so, sometimes there is a little bit of a ramp up for cataloguers to be able to get back in the swing of things. The ones – the nice surprise or maybe not surprise if you believed in print all these years, is sort of the book story. We’ve seen that the printed book volume was really up about 3% for the industry, which I think continues to tell the story that the transfer to digital is real, but it’s not ever ending and it’s really about media mix and I’d say that the big trend that I am seeing as represented by the robust conversations we had last week with a lot of our clients, most of the time, we are not focusing on print in this conversation, we are focusing on how do you get more out of your ad spend and what seems to happening and I’ve always talked about media confusion, but I think people are recognizing, we’ve also been sort of in a crisis of measurements and so if you look at adage and all the different industry letters, you are going to see a lot of talk about measurement, right now. In fact, it was – I was very pleased to see Sir Martin Sorrell who is the Chairman of WPP the biggest ad agency in the world a couple of weeks ago make a pretty serious statement, because he has been very aggressively moving their agencies to push people to take advantage of online digital. And I think the realization is happening as digital is becoming very fragmented. And if you look at some of the big – like P&G is going to be consolidating the number of ad agencies and if you read into some of their statements, they are talking about the productivity cost that come with administering digital advertising dollars to all these different fragmented areas. And I think people are taking a step back and the word that you are going to hear a lot of now is engagement. And that it’s not just about whether someone clicks on you, it’s do they truly engage with your brand and his statement was is that, we’ve really gone very far to the pendulum has kind of swung on the digital spend side, that we may have pull back a little bit too much on traditional media as he is seeing data that talks about how effective specifically magazines and by the way newspapers are at engagements. And so, there is a balancing act that’s trying to come back into play here in how people measure the spend of the consumer and what causes what. The term attribution is about, okay, what channel drove what to another channel. And so if you purely measure digital for instance, I have a long time client called NewPic Corporation, great business-to-business company. They talked about when the last big postal rate came through, I said, well, so what do you guys going to – are you going to cutback like everyone else’s piece, said well actually we are increasing, because we just went through a very deep analytic cycle of understanding our different media channels and they found that, every time they increase the catalogue the effectiveness of all the other digital channels became much more robust. And so what we heard strongly last week, but it’s something I’ve been advocating for years now, is that it’s about using all channels and using them effectively. And as you look at what the MTA is doing, and the various publishers, we had Michael Clayton from Hurston last week doing a keynote because I think they’ve done a wonderful job not just enhancing print with all the different covers they are doing in creativity, but also very much on the multi-channel side along with people like Conde Nast and Time Inc. and Meredith. And, sort of the message is that, they spend less time focusing on ad pages in print and more about engagement of the consumer for the advertiser. And so a lot of things that are happening are people just trying to look at their own organizations and saying, hey, we’ve got to figure out how to become less siloed as it relates to the consumer, because, when your measurement is well, I am here to try and drive things to happen on the web as part of an advertising effort, that’s my measurement. But you may not understand it’s a measurement wrong that print may have a big thing to do with that. And so it’s kind of a long winded way to say that, we are really seeing the conversations heat up on multi-channel surrounding measurement. And again, it’s becoming a lot more about engagement and that’s happening within the digital side, whether you are talking about the effectiveness of video, people are talking about the engagement factor. And so, it really leads me to feel good that even with ad pages being down again, circulation is staying pretty solid that, that I think the pendulum will start to swing back a little bit and I am not expecting things to be on prior tomorrow, but I feel confident that the world is figuring out the mix thing as very important to understand.

I appreciate the color. Dave, if I could turn to you, one number that I was intrigued by in the earnings release was, if you look at kind of a gross margin sort of number, net sales minus cost of sales, this is actually the first quarter where you all have had a year-over-year improvement in that number since I believe the third quarter of 2011 where there was a lot of world color noise and the number is kind of bouncing around a lot. So, I was – I don’t want to read too much into a single quarter’s number and particularly not a Q1 number, but, can you talk a little bit about maybe some reasons behind that increase?

Yes, Jamie, and as you known from our comments and our prepared comments, one of our key strategy that’s continue to drive productivity through the business. We are a big advocate in the shop floor and in the admin area and lean enterprise and how you take cost out of the system and still maintain quality and effective delivery for your customer. So this is – a lot of that is a continuation of that continuous productivity and cost takeout and doing things more effectively. There was also in the quarter, a change that came through because that we conformed vacation policies, most recently from some acquired companies and that did benefit that line by almost $4 million, But it’s a combination of continued cost takeout plus that that reserve adjustment that did come through that cost of sales line that makes up the entire movement of that number.

Okay, very good. I’ll get back in queue. Thank you.

Thanks Jamie.

Thanks Jamie. Operator, next question.

The next question comes from [Indiscernible] of Sidoti & Company. Please go ahead.

Good morning.

Good morning. How is everyone doing?

We are good.

First question, you mentioned the Copac Global Packaging acquisition, can you provide more information, especially what I am interested is in their innovative packaging and supply chain solutions. How does that benefit you? What benefit do you see?

Yes, I mean, so this is not a huge acquisition, but a very important one, because, as we’ve embarked in packaging, we started out with Proteus which was a good family company with a great platform, really good people, a good talent and innovation of design. As we became acquirers, we also like to be a place that people want to place their good assets when they are ready for a change and Copac has built a nice business over time. They are also in the Dominican Republic servicing some of those product lines down there for some of the star people and things like that. But, it works very well with what we’ve done with Proteus, similar product lines, it’s a way to expand our efforts and continue to build our base as well as build our talent base, as we become more formidable on packaging, we want to make sure just as we’ve done in the other acquisitions that we always look for good people, good talent, which means, you are bringing things like innovation. One of the things we bring to all this is, we are very good at supply chain. We are very good at pulling out synergy costs when you look at the combination of it, no matter sort of what you are playing in. But again, this is a continuation of our strategy to do the right acquisitions and not necessarily worry about and it doesn’t have to be big or small, it just got to be the right one.

Okay, one more question. Can you provide any updates regarding QuadMed?

Yes, QuadMed continues to do what it does and I think one of the most important things QuadMed does for us as a corporation is, it takes key control of our own costs as a printing company and as we’ve said over time, we’ve been significantly lowering costs than all other industry for our employees and I think that’s becoming really important as in places we are trying to hire, I think that benefits are going to be a big deal. On the outside business side, they continue to grow their pipeline. We’ve got several big implementations going on right now with some large industrial companies and the exciting things is that, Su our President there has really brought in some great talent to kind of round out her team. So we can continue to scale up. Again, this is an insignificant part of our business from a side standpoint. But the innovation that they bring to us with other companies and ours continues to be a big way we also reduced our cost as a printing company.

Okay, thank you very much. That’s all for me.

Operator, any other questions?

No, this concludes the question-and-answer session at this time and I would like to turn the conference back over to Joel for any closing remarks.

I know you know, this is the first quarter, we got three more to go. We’ll see you soon. But again, I think we are very pleased with our continued strong free cash flow, this is a quarter where it was positive versus negative, but our focus on driving the platform as well as building our offering to our clients is going to continue on as we said and we’ll be updating you as it happens. So, with that, we will see next quarter.

The conference is now concluded. Thank you all for attending today’s presentation. You may now disconnect.