Quad/Graphics, Inc. (QUAD) Q1 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Quad/Graphics' First Quarter 2018 Conference Call. 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 this event is being recorded. I will now turn the conference over to Kyle Egan, Quad/Graphics' Senior 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 a detailed discussion of our company’s ongoing transformation. Dave will follow with a more detailed review of our first quarter 2018 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 2. 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.

Thank you, Kyle. And good morning, everyone. I am pleased to report that our first quarter 2018 results were in line with our expectations and we continue to focus on accelerating our Quad 3.0 transformation. In Quad 3.0, we leverage our strong print foundation as part of a much larger and more robust integrated marketing platform to create greater value for our clients at the time of significant market disruption. To fuel our Quad 3.0 transformation, we have a strong and engaged workforce backed by state-of-the-art technology to generate the earnings and cash flow necessary to further advance our value-creating strategy. Our goal, as always, is to remain a high-quality, low-cost producer across the continuum, from traditional print to multi-channel execution. Key to our success in Quad 3.0 is our ability to expand our capabilities quickly and have the appropriate resources to scale in a significant way. To accomplish this, we take a disciplined “build, partner, acquire” approach to [Audio Gap] accelerate our transformation. In core strategic functions, we hire marketing professionals with client-side experience and build the capability from within. When seeking scale and complementary offers, we partner with companies whose expertise helps us fill a specific gap or amplify our offering. Rise Interactive is one such company with whom we’ve partnered closely with since July 2016. Rise specializes in digital media, analytics and customer experience. In March of this year, we increased our equity position in the company and now own a controlling interest. This investment capitalizes on Quad’s expertise in optimizing a clients’ marketing spend in offline channels with Rise’s expertise in online channels to create more integrated multi-channel campaigns bridged by the expertise already in place with our Blue SoHo and Ivie businesses. Together, we’re strategically advancing data-driven marketing through the delivery of highly relevant consistent messages at scale to consumers across digital and print channels. Our increased investment in Rise complements our recent acquisition of Ivie & Associates, a leading marketing services provider. Ivie is a leader in customized marketing and business process outsourcing, and Quad together with our Blue SoHo team is a leader in content production and workflow process optimization. The combined offering provides our clients with unmatched skill for on-site marketing services, integrated execution and expanded subject matter expertise in digital, media and creative. Together, Quad, Blue SoHo, Ivie and Rise create a stronger, more powerful integrated marketing platform that we believe is unmatched in the marketplace. As independent companies, we would not generate the same level of client value that we do from stacking our media solutions together as a single well-integrated entity. Whether we build the capability internally, acquire the expertise externally or increase our investment in an existing partnership, the result is a strategy centered media integration from understanding data insights, building strategy and developing creative to buying media and deploying content across various channels. In Quad 3.0, our expertise in planning and efficiently buying media on behalf of our clients has grown to well over $0.5 billion and has expanded from traditional print to digital channels and now includes TV and radio. We not only fulfill traditional agency roles of concepting and planning media but provide integrated marketing execution across online and offline channels. As we transition from a vendor who makes products to a full scale provider of marketing solutions, we will continue to deliver increased value by helping our clients reduce the complexities of working with multiple agencies, while also improving their process efficiencies and marketing-spend effectiveness. We will continue to scale our offering based on client need. We will be strategic in the way we expand our integrated marketing platform in Quad 3.0 to ensure our functional products and services stack together to generate additional revenue across all of our businesses at a time when industry headwinds continue. For example, this morning we announced a significant direct mail win in the financial services vertical. Under a newly signed multi-year, multi-million dollar agreement with US Bank, Quad now manages the credit card acquisition program for hundreds of its small and mid-size regional banks. The volume for the US Bank program is significant, more than 70 million letter pieces per year, all hyper-personalized with data elements highly relevant to each individual recipient to increase engagement and inspire action. Our best-in-class direct marketing solutions help US Bank increase the effectiveness of its marketing campaigns while also reducing its production and distribution costs. Another key area of focus for us in Quad 3.0 has been data security and healthcare vertical. We were proud announce earlier this week that we earned HITRUST CSF Certified status for our HealthVision Solution and the high-compliance environment for the healthcare vertical. This important status is a differentiator for Quad and demonstrates that we are appropriately managing risk by having met key regulations in the industry-defined requirements in healthcare. This achievement places Quad in an elite group of organizations worldwide that have earned this certification. But more importantly, HITRUST CSF certification sends a strong message to all our clients that we care deeply about process and data security and have the appropriate information protection requirements in place. My thanks go all out to all the employees who made this certification possible. Before I hand the call over to Dave, I want to emphasize how confident we are in Quad 3.0, and we will continue to remain focused on our consistent strategic priorities to generate sustainable strong free cash flow, drive further EBITDA enhancement, strengthen the balance sheet, demonstrate our ongoing commitment to providing long-term shareholder returns and continue to accelerate Quad 3.0. With that, I will now hand the call over to Dave.

Thanks, Joel. And good morning, everyone. Our first quarter 2018 results were in line with our expectations, and we remain on track for delivering our 2018 financial guidance. For comparative purposes, the first quarter of 2018 includes the acquisition of the marketing services firm Ivie & Associates. We completed this acquisition on February 21. It also includes our increased investment to a 57% majority stake in the digital marketing agency Rise Interactive. This was completed on March 14. The financial results from both strategic investments are included in the first quarter results from the date of their acquisition and are included in our 2018 financial guidance that we provided on our previous earnings call. Slide 4 provides a snapshot of our 2018 first quarter financial results as compared to 2017. Net sales were $968 million, down 3.1% from 2017. Organic sales declined 5.1% due to ongoing print industry volume and pricing pressures after excluding 2% positive impact from acquisition. Organic sales also exclude offsetting impacts from pass-through paper sales, which declined 0.2% in foreign exchange, which increased sales by 0.2%. The organic sales decline is in line with our annual sales guidance, assumptions including continued downward price pressures of 1% to 1.5% and organic volume declines of 1% to 4%. Adjusted EBITDA decreased $8 million to $111 million as compared to $119 million in 2017. And our adjusted EBITDA margin declined 4% to end the quarter at 11.4% compared to 11.9% in 2017 due to the organic print sales decline, partially offset by cost reduction activities and contributions from acquisitions. As a reminder, beginning in 2018, we began reporting adjusted EBITDA without pension income due to a change in US GAAP that requires pension income to be excluded from operating income and by default non-GAAP adjusted EBITDA. As a result, Q1 adjusted EBITDA excludes $3 million of pension income in both 2018 and 2017. Our 2018 adjusted EBITDA also includes a $17 million gain from insurance recoveries associated with a press fire, which was partially offset by a $10 million net benefit realized in 2017 from a change in our vacation policy. We are pleased with our adjusted EBITDA and EBITDA margin performance during the quarter, as it reflects our team’s continued focus on proactively matching our cost structure to the realities of the revenue pressures we face in the print industry, while still allowing the company to invest in Quad 3.0 transformation. Free cash flow was negative $22 million in the quarter as compared to $40 million in 2017 and it was in line with our expectations. The decrease is primarily from an expected decline in cash provided from working capital due to timing differences between 2018 and 2017, as working capital benefits in 2018 will be more weighted towards 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 be primarily generated in the second half of the year. We expect our full year 2018 free cash flow to range between $200 million to $240 million, which represents a cash conversion of over $0.50 of free cash flow for every dollar of adjusted EBITDA that we earn at the midpoint of our guidance ranges. Slide 5 includes a summary of our debt capital structure as of March 31. Debt increased $68 million to end the first quarter at $1 billion due to $74 million of net cash paid for the Ivie and Rise Interactive acquisitions during the quarter. We also repurchased $8 million in shares during the quarter to help partially offset dilution from annual equity grants. We intend to repurchase more shares to continue to offset dilution from equity grants and also to offset our $22 million in shares granted for special retirement contribution we made in the first quarter as part of investing a portion of the benefit of tax reform back into our employees. As of March 31, 2018, $79 million of authorized share repurchases remain available under our $100 million share repurchase program. We finished the quarter with debt leverage of 2.28 times, well within our long-term and consistent target range of 2 to 2.5 times leverage. Our debt capital structure is 6 3% fixed and 37% floating, with an advantageous blended interest rate of 5.2%. We have no significant maturities of our debt until January of 2021 and available liquidity under our $725 million revolver with $623 million as of March 31 - shows our commitment to our dividend, which is one of the ways in which we’ve return value to our shareholders. Our next quarterly dividend of $0.30 per share will be payable on June 8th of 2018 to shareholders of record as of May 21st of 2018. We consistently paid a quarterly dividend and our annual dividend of $1.20 per share is yield approximately 5%, but only represents 28% of our free cash flow at the midpoint of our guidance range. While much of the year still remains in front of us, we are pleased that our first quarter results were in line with our expectations and that we remain on track for delivering our 2018 financial guidance. We hit the ground running on integrating the Rise and Ivie acquisitions into our multi-channel marketing services offerings and are excited about our opportunities to create more value for our clients and our shareholders through an integrated marketing platform that reduces complexity, increases process efficiencies and improves marketing spend effectiveness. Now I would like to turn the call back to our operator, who’ll facilitate taking your questions. Anita?

We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from [Jamie Klima] with Buckingham Research. Please go ahead.

Hey. Good morning, gentlemen. Hey, Joe, I was wondering, with post Ivie acquisition and with the bigger investment in Rise, could you kind of give us a sense as you look out over the next 2 or 3 years, where you think you are in terms of the whole buy versus build versus partner mix on the marketing services side?

Yeah. I mean we're going to continue to scale all of it. And I think we mentioned in the last conference call that we have another $10 million of investments we're doing this year in talent alone, and that's really because we need to build it because the demand is there. What's interesting, as soon as we closed the Ivie deal, we were already day 2 participating in a couple of major RFPs, where Rise was brought into the loop where they want to it before. And so it's really resonating with our customers as we've done because they're telling us this is what they want. They want the integration. They want the simplicity built into a very complicated world that they're dealing with. So all the stuff that we're doing is because the demand is there and the customers' reaction is great. And I think I mentioned it in the script. But today Quad is buying on behalf of our customers well over $0.5 billion worth of media spend, which is really not reflected in our numbers, but it's important growth as we go forward so that we can efficiently buy different media channels for everybody. And the TV and radio aspect will not -- not large today is new to us with the acquisition of Ivie. And so I kind of look at all the things that we're doing together in the fact that we can keep this really integrated. Again, I'm so impressed with the talent at both Rise and Ivie and the cultures are so similar that -- it's not about -- there is not a lot of brain cell been killed right now about who does what. It's more long life of how can we go faster, because we have active conversations with many customers that we’ll be able to do some announcements in the near future. So yeah, I mean it really depends on the world is changing quite a bit right now. There is going to be a lot of shakeout in ad tech and marketing tech. There is a lot of shakeout in the home marketing happens. And so it's really important as people think about 3.0, it's sort of I mentioned the stake, because I need people understand that so we've got at the bottom of the stake, all the products, the tangible products we produce in print, in store, packaging all those different things that we're going for, combined with all these enhanced marketing services at the top, and any conversation we have with clients right now is coming through any part of that stake. So we could be selling someone business cards and that could result in suddenly a services conversation that leads to direct mail or leads to retail inserts. It all kind of works together and it kind of goes up the stake and down the stake, depending on how well we can have an effective conversation. And it's happening quickly. So very pleased with it. And I'd say, in 2 to 3 years, you'll continue to see Quad remake it itself at a very fast pace.

Yeah. So would you still be open to a consolidating type of acquisitions on the print side?

Let Dave start and I can follow up.

Yeah. Jamie, I think it's a fair question. It's a question we get asked a lot. And as Joe talked about with the stack, it's just as important to have the execution assets as it is to have the marketing solution -- services to add to a total solution. And you've known our history as an acquirer. We’ve been very disciplined. And we’ve always kind of looked at consolidating acquisitions from a very disciplined mindset, whether it was World Color, Brown, Vertis. And so we look through kind of four criteria for these acquisitions: One, is it strategic fit? Two, does it make economic sense? And by economic sense it really comes down to valuations. Three, can we successfully integrate it? And we’ve walked away from deals where just because of the way our model of doing business with so different than another company’s way of doing the business, we didn’t feel we can integrate it properly. And the final is, we have to take care of that balance sheet. And so we want to make sure that the strength of the balance sheet is just strong after the acquisition when we’ve had a chance to put the synergies into place than it was before. And so that really comes back to valuation. It’s probably the most important thing we look at in terms of those criteria right now and making sure that the economics make sense. The Print segment itself needs further consolidation. It’s highly, highly fragmented still, and there’s a significant amount of underutilization of capacity from print having to compete against all media channels. So there is opportunities there, but I think we are going to be very patient. We are going to very disciplined on price. And for instance, the disciplined on price goes well beyond just kind of looking at the synergies associated with the deal, move up hard at the cost to achieve those synergies. And whether or not the realistic cost to get to a synergy that allows us to have a sufficient return for the amount of money we are spending, we also dig heavily into the metrics of a company, such as the quality of earnings and the free cash flow conversion to understand that the true value that those assets are generating are there. And so we are going to continue to show this discipline as we’ve done in the past, and we will continue to show appropriate patience until a company’s valuation reflects the reality of its true performance and its true outlook.

Yes, maybe I add to that you check those boxes and we’re pretty good at this. And as you look at our strategy, it really is we do believe that print will continue to play a significant role. But if you do it well and you can really kind of manage all that together, it really does continue to create a lot of fuel so that we can continue to transform as well. So everything kind of works together; but again, I think that we’ve been very good about being disciplined in all the aspects that Dave talked about.

The next question comes from Dan Jacome with Sidoti & Company. Please go ahead.

Hi, good morning. I just had a couple of questions. First on the free cash flow guidance as that appear still intact. Can you just -- seasonal components aside, what gives you confidence that you will be able to achieve that later this year? That was just my first very general question.

Yes, so it’s really the high quality of the earnings we have and the conversion of those earnings into cash flow. We currently generate over $0.50 of cash flow for every $1 of EBITDA. So we feel really, really comfortable about where the year is headed in terms of our EBITDA production and what that’s going to result in terms of free cash flow. Working capital for us was just -- we knew this was going to be a timing item. But we have talked about on the past calls we’ve done a substantial amount of continuous improvement in how we manage our working capital. And we’ve been able to generate well over $250 million in increased cash flow because of working capital improvements we’ve made to reduce the days it takes to bill, to improve our collection days and better manage our inventories. We've been through a lot of the heavy lifting in that, and so those benefits are slowing down a bit. But yet we're getting more towards those seasonal creations on working capital that you'll continue to see for us. And so that will built into the fourth quarter. You'll see a lot of it there. And like you’ve seen with any kind of major printer because of the seasonal nature of our business, all that cash starts coming in late third quarter into the fourth quarter as we hit our peaks.

Okay. Just for modeling purposes, would you say, if you had to pick one, would it be more skew to inventory discipline or things like DSO?

It's been DSOs for us. It's been primarily billings, and reducing the amount of days that take to get a bill out and get it collected. So most of our improvement you seen, it’s all come from the receivable side. And then I would rank it – that would be inventory and the third is from just standardization of payables terms.

Okay, great, that helps. And then just wanted to pick your brain for a second on what sort of statistics you guys are seeing for TV and radio ad spend and demand, things of that nature. I've seen so many various numbers out there over TV up to and then for radio flat to down 2%. But you sound pretty bullish on these incremental marketing channel. Was that you're hoping customers with? And I think, longer term, it definitely has promise, but I'm just trying to better understand from a very high level, what the demand or industry year-over-year changes everyone have seen?

It's less about what are the trajectories in any one of those verticals. But the reality is, as we take over or get much more involved in the marketing strategy or execution of someone's marketing strategy, the services we need is that media buying. Whether we have most of it, it's just radio and TV we're missing. And you know there is all sorts of ups and downs going on, but the fact of the matter is it still required to be able to do it. And so by adding the capability, I think we'll be able to build on it, but certainly right now a more significant part of our media spend is going to be in the other channels, but we'll build on this. And I could see us going north of $1 billion in media buying in fairly short order as we sort of continue to ramp this up. So again, I’d want to repeat that marketing is being disruptive. So this is not about printing disrupted alone, it's all of marketing speed disrupted. You can watch it in the gyrations that are going on with WPP, the holding company. The issues aren’t just around the resignation of the CEO for his issues, it's actually has a lot to with the fundamental change in the marketing model. And the fact that there has been so much overspending and over-indexing in many different digital verticals, without the prerequisite measurement to go along with it, and everyone is figuring that out. So it really kind of shifts how people are thinking about. They really are looking at what is the effective position of my spend? When I spend the money, is it doing something? Is it raining the cash register, and that's why we're growing so fast into this areas out of the demand of simplifying it but also getting visibilities to how all these different channels work together. Does that make sense?

Yeah, absolutely. Absolutely it does. Thank you.

You're welcome. Operator?

This concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Okay. Well, thank you all for joining us. We look forward to rejoining you next quarter. Have a great week.