Quad/Graphics, Inc. (QUAD) Q1 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Quad/Graphics First Quarter 2017 Conference Call for Analysts and Investors. During today's call, all participants will be in listen-only mode. [Operator Instructions] A slide presentation accompanies today's webcast and participants are invited to follow along, advancing the slides themselves. To access the webcast, follow the instructions posted in last night's earnings release. Alternatively, you can access the slide presentation on the Investors section of Quad/Graphics website under the Events & Recent Presentations link in the left-hand navigation bar. Following today's presentation, the conference call will be opened for questions. [Operator Instructions] Please note that today event is being recorded. I like to turn the conference call over to Kyle Egan, Quad/Graphics' Manager of Treasury and Investor Relations. Kyle, 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 highlights of our financial results along with discussion of our path forward in 2017. Dave will follow with a more detailed review of our first quarter 2017 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 on slide two. 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. A replay of the call will be available on the Investors section of our website shortly after we conclude. The slide presentation will remain posted on Quad/Graphics website for future reference. I will now hand the call over to Joel.

Thanks, Kyle, and good morning, everyone. I am pleased to report that our first quarter 2017 results were in line with our expectations. Adjusted EBITDA and adjusted EBITDA margin both increased compared to the same period in 2016. In addition, due to our ongoing focus to reduce debt, our debt leverage ratio improved from last quarter. On our path forward work, we are focused on five key priorities which are to generate strong free cash flow to support value creating opportunities that are part of our continuing transformation, drive further EBITDA enhancements through ongoing sustainable cost reductions and productivity improvements, while remaining focused on incremental revenue. Strengthen the balance sheet through debt and pension liability reductions with a focus on improving our debt leverage ratio, demonstrate our ongoing commitment to provide long-term shareholder returns through our annual dividend of a $1.20 per share and continue to strategically invest in our Chapter 3 transformation, while strengthening our core platform. Our Chapter 3 transformation follows what we have done over the last 46 years, which is listened to our client's needs, invest where necessary and transform to further expand our value creation. Our transformation is ongoing and evolving and built on a simple premise to create a better way every day. Today our transformation coincides with the seismic shift going on in marketing right now as marketers and publishers try to create more content for more channels with the same or fewer resources at a faster pace, orchestrate activities across the right mix of media channels to break through the noise, increase response and loyalty and activate the right message by the right media at the right time. The artwork portrayed on Slide 3 of today's presentation is a visual representation of how Quad is helping our clients. We are focused on developing products and services that skilfully weave together multiple online channels with offline channels to work in unison and produce better results for our clients. The cyan magenta, yellow and black strands are CMYK, represent our strong foundation in print, the red green blue strands represent the RG B electronic color model. Together these channels represent our continued evolution as a marketing services provider. Data of the one scene is woven throughout and is the driver that enables our clients to deliver individualize messaging at the right time through the best mix of channels. As we continue along our journey to redefine our company in today's multi-channel world from a printer who just produces high quality of products, to also a marketing service provider, we will create value in two distinct ways. First, we will help our clients market more efficiently and effectively using our strong print foundation in combination with other media channels. Creating efficiencies with regard to content creation has always been a part of our offering. By tapping our expertise in CI or continuous improvement which includes lean enterprise and process engineering, we help our clients manage their content work streams and for some we do this onsite at their location. We also use our expertise to help clients improve the effectiveness of their marketing spend by helping them coordinate the strengths of different channels. Our goal is to better inform and measure clients marketing decisions across all channels and allow clients to iterate that process much faster. Second, with an engaged workforce, we will continue to invest in then strengthen our core manufacturing platform, to in short remain the strongest and more sustainable in the industry. In addition, we will continue to aggressively manage costs and improve productivity to hold the line of adjusted EBITDA margins. This supports our goal being the industry's high quality, low cost producer, while generate strong free cash flow to support value creating opportunities as we transform over time. Before I hand the call over to Dave, I would like to extend my sincere thanks to our employees for their ongoing dedication, determination and hard work as we maintain our strong culture, while we evolve from a critical commodity vendor to a trusted marketing partner. They play an important role in Quad/Graphics transformation and make it possible for us to create a better way every day. With that, I will now hand the call over to Dave.

Thanks, Joe and good morning everyone. We delivered first quarter results in line with our expectations and we remain on track for delivering our 2017 financial guidance. Slide 4 provides a snapshot of our 2017 first quarter financial results, as compared to 2016. Net sales of $1 billion, were down 4.2% from 2016. Organic sales, which exclude pass through paper sales and foreign exchange impacts declined 2.8% due to ongoing industry volume and pricing pressures. Pass-through paper sales decline 1.2% and foreign exchange losses negatively impacted sales by point 0.2%. The organic sales decline of 2.8% is in line with our annual sales guidance assumptions, which anticipate a volume decline of 1% to 4% and a price decline of 1% to 1.5%. Adjusted EBITDA increased $2 billion in the quarter to end the quarter at $122 million, as compared to $120 million in 2016 and our adjusted EBITDA margin increased 70 basis points to 121.2% compared to 11.5%. The increase in adjusted EBITDA despite lower net sales was driven by lower cost of sales and SG&NA and included a $5 million net year over year non-recurring benefit from a $15 billion reduction in our vacation accrual, partially offset by a $10 million onetime benefit we recognized in 2016 from the collection of a vendor receivable that was previously written off. The company generated $40 million of free cash flow in the first quarter compared to $86 million in 2016, representing a $46 billion decrease between years. This decrease was primarily driven by an expected reduction in the benefit from our controllable working capital improvement program. We generated $36 million in cash flow in the first quarter of 2017 from this program, as compared to $63 billion in 2016. Our controllable working capital improvement program has generated well over $200 million in sustainable improvements and free cash flow to date and still has more room to go as evidenced by the $36 million in sustainable reductions recognized this quarter. Our overall free cash flow result in the first quarter are consistent with our annual free cash flow guidance of $225 million to $275 million. Slide5 includes a summary of our debt capital structure as of March 31st. We continue to remain focused on strengthening our balance sheet through debt reduction. This December 31st of 2015 we've reduced debt by approximately $250 million and finished the first quarter with $1.1 billion in debt in capital lease obligations. Our first quarter free cash flow drove $28 billion and further debt reduction and resulted improving the debt leverage ratio to two point to nine times. We continue our focus on debt and pension reduction as the primary use of cash and believe that operating within our consistent leverage range policy of 2 to 2.5 times over the long-term is the appropriate target. As a reminder, we may operate outside this range depending on the timing of compelling strategic investment opportunities. Available liquidity under our $725 million revolver was $685 million as of March 31. We have no significant maturities until January of 2021. And our overall blended interest rate is 5%. Our balance of fixed to floating rate debt shifted more toward fixed rate debt in the quarter following a five year $250 million interest rate swap we entered into. Our debt capital structure is now 62% fixed and 38% floating. Given the flexibility under our revolver, our advantageous cost of borrowing in our free cash flow generation, we believe we have sufficient liquidity for current business needs, pursuing future growth opportunities and returning value to our shareholders. Slide 6, shows our commitment to our dividend, which is a key way in which we return value to our shareholders. Our next quarterly dividend of $0.30 per share will be payable on June 2nd of 2017 to shareholders of record as of May 22nd 2017. We've consistently paid a quarterly dividend and our annual dividend of a $1.20 per share is yielding approximately 4.5%, but represents only 25% of our free cash flow. While much of the year still remains in front of us and our revenue is weighted more toward the seasonal back half of this year, we're pleased that our first quarter results were in line with our expectations and that we remain on track for delivering our 2017 financial guidance. As we move forward in this challenging industry, we'll remain focused on driving further EBITDA enhancement and strong free cash flow generation by adding new business and continuing to focus on cost reductions and productivity improvements. Strong earnings and cash flow will allow us to strengthen an already healthy balance sheet through ongoing debt reduction, while also continuing to invest in our business to accelerate the transformation of our go to market strategy and return capital to our shareholders through our quarterly dividend among other priorities. And now I'd like to turn the call back to our operator to facilitate taking your questions. Jamie?

[Operator Instructions] And our first question today comes from Dan Jacome from Sidoti. Please go ahead with your question.

Good morning, Joel…

Good. How are you? Can you hear us?

Yes. Okay, great. Appreciate the time. I had a couple quick questions here. Well, I just start with postal cost, I just wondered if he had an update on rate overall. But you know keep it more generally, what's tone overall with your customers and how they're feeling about postal rate and just other related distribution costs right now?

Yes. I think we've - I think our customers are you know in a fairly good place right now because of some of the changes that happened last year. But I think the big deal is you know, the postal bill that we've all been working on for a number of years that has been in pretty good shape with a lot of agreement from a lot of the constituents on what can really create a lot of relief for the post office. And creating that relief is really important, you know, things like the, you know, pre-retirement or funding of health care you know and some of the things that you won't have to do normally in a business, really speaks to what they can do on pricing on a go forward. I think the challenge right now is that in the house you have Chairman, Javits [ph] just announced that he is no longer going to stay in government or at least not in federal government. And he was you know really sort of on guard and leading the charge on the health side. So you know, there's going to be a little bit of sort of wait and see in terms of how the void is filled. But you know having unions, as well as different customer constituents sort of generally aligned with what the bill looks like is very important. And obviously as we know there's a lot going on in Washington, so sometimes it's hard to push things forward. But you know, we stay on it. In fact, we have people there this week working the hill to try and continue to push it forward. So you know I think we're in fairly good shape for the time being in terms of stability in postal rates. But I think a lot needs to come as we sort of keep pushing forward with postal reform.

Right. Yeah, you know everything I read it shows Quad/Graphics is heavily involved in the conversation, so that's why I was asking. Just wanted to turn it over to the digital print, 2% are you guys started in December, I think in New Jersey. Just remind me again how is that going, did you get all the digital presses up to the kind of operational level you wanted and then longer term, what do you think it's going to do for the business?

Well, I think that's actually just one part of the whole digital strategy. It's actually going quite well, and we've done some consolidation that's really kind of works towards that goal. But you know the digital platform is actually quite robust to acquire you know from out in Westhampton, and in sort of the East Coast, but also Versailles, Kentucky, up here in Wisconsin, we literally have a lot of equipment at play. And it depends on the product line that you're talking about. So you know in book publishing It's a big deal you know with the new work we've taken on from Cengage and how we're executing for them it's about getting rid of you know, inventory for them on the books side, which is what the book industry needs to do, where you're using you know digital print operations to really kind of lower the back size, so they don't have to take a big advance on inventory, you know from a direct mail standpoint, throughout our platform it really is about getting to one to one marketing and as we sort of see the online channels and online channels converge, you're really talking about a lot of trigger based marketing where you are truly speaking to the individual with images actually changing on the fly. But it's also about you know a combination of what's the right technology at the right time. I mean, sometimes a digital print press will make sense because of the variability, sometimes it won't. And many times there will be a hybrid of it which we do in a lot of our direct mail now, where you have traditional printing press combined with a digital press to give the best of both worlds based on the economics. So it's all ROI based, but clearly you know, the world of both the variability and personalization is here and it's been here for a long time for us, we've been doing it for close to 30 years. But as dot.com 2.0 continues to mature and as marketing continues to realize that the pendulum needs to swing a little bit back to the center of the world not being completely only digital but digital and physical, you'll continue to see I think that technology take off. And it's really based on the ROI on your marketing spend. We know that personalization drives a higher ROI through high response rates, whether that's online or offline or mobile. And so it's going very long in short and we'll continue to keep investing heavily in the space.

Excellent. And then just one quick last one and then I'll get in the queue. Just thinking forward to the second half, I know it's seasonally it's usually better for you guys. Can you give us a little flavour or maybe the tone for advertising budgets on customers, page count, anything you can give us you know, is it kind of steady as you go, and anything maybe in the first half of the year that is helping you think about what the second half might have for us, I know it's only May, but...

Well you know, for first quarter or second quarter is the seasonally low part of the year. First quarter, I think we saw a lot of sort of reactionary things happening based on fourth quarter, but also there's a lot of reaction going on in the world in the first quarter to all the events surrounding us. But there's continued pressure especially on the retail space. But I really look at that as opportunity because you know we're engaged in a very different level of conversation with a lot of our retailers because they're looking at how we can continue to offset some of the challenges they've had. And I think it's easy for people to say that retail is being disrupted and that's what's causing everything. But I would just add a word of caution that there's two things going on, there's certainly disruption, but there's also the fact that this country is so over stored in the retail markets. And so you saw you know 3200 stores closed in the first quarter, but you saw 2500 other new stores open. And if you really compare the retail space in the United States from a brick and mortar standpoint, you know, as a per capita basis in terms of square feet there's five times more square feet per capita than the rest of the developed world. So you're saying two things, you're seeing you know, a reset on the size of the footprint, but then you're also seeing disruption which is going to lead to a reset on the model. And those who go fast and those who realize that it's about urgency and it's about a new model and it's about adjusting quickly you're going to win, and the ones who can't or won't will disappear. And so you know with that I think the retail space is where we've seen a lot of pressure. But again it's early in the year and we really you know, the second half is when everything happens. So we don't read too much into you know, the current pressures there. As well as on the advertising paging page front with our publishers, you know there's some noise going on with potential combinations and consolidations. But ultimately the same holds true, you know, those who move fast and adjust their model and invest in quality content are going to win and those titles and those things that haven't are going to cease to exist. And so it's going to be an ever evolving world. But we plan for this and we have been very straightforward with this all along that we expect continued downward pressure in the industry. However, we see that as a real opportunity as we expand our offering to sell more to the clients we have and gain more clients because of that broadening offering. Does that make sense?

Yeah, absolutely. I mean we just keep caring about the world coming to an end on that retail landscape, but you know, where you basically think that the optics can be a little bit...

Yeah, I mean...

You've already baked into your strategic plan?

Yeah. I mean, it reminds me of 2011 when Borders went out of business in the book world and it was at the same time obviously the Kindle was you know going crazy and the Kindle Fire was about to come up. You know everyone attributed a huge volume drop to the Kindle, when in fact it had a lot to do with the disruption of inventory because of the Border dislocation that all of that inventory had to go somewhere and there was disruption going on. But if you watch what happened in the book world today you know, the pendulum swung back and actually you know books are up, printed books are up and digital is significantly down. And so I think you know people have to be careful. If everyone is being disrupted today and it's very easy to say that well that means everyone is going to die. Well that's not that's not what is going to happen. It's going to be - there are going to be winners and losers. And I think as a partner to our clients you know, the more that we can develop our offering that helps them with that ROI marketing spend, it implement it faster and get them to implement it faster. You know, the sense of urgency is huge because disruption keeps speeding up. And again, the pace at which winners win is increasing and the pace at which losers lose is increasing as well.

Right. Yeah, they need you more now than ever probably.

And when people are in that space they're more willing to listen to try things. And you're seeing disruption in terms of who they get advice from, like the big agency group, you're seeing Procter & Gamble and Unilever throw down on the traditional measurement model who is digital. They want more transparency and they want ROI because they're seeing the ROI go down. And a lot of them are realizing that okay, we're out of whack and the measurements are wrong and we have to get back to a connected measurement that's completely integrated across all channels because all they care about ultimately in marketing is when I spend a dollar on marketing spend, does it create $5 of revenue or $10 of revenue. And I think so often people can you know look at the shiny new object and just start spending on it regardless of measurement and digital was the Wild West. And now it's coming back to reality where the measurement has to back up to technology.

Okay. Really appreciate all that high level color. Thank you very much.

You're welcome. Operator, next question.

[Operator Instructions] And ladies and gentlemen, at this time I am showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

Great. Thank you, operator. Well you know, we're pleased with a good start to the year. Again, first quarter doesn't make or break a year, but I think that it shows that we continue to manage at a very aggressive pace, but also feel very good about the model that we're creating, really to help everybody in our client base in this sort of ever changing world that continues to speed up. So we look forward in the next several quarters to continue to update you on our progress. Thank you for joining us.

And ladies and gentlemen, at this time we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.