Quad/Graphics, Inc. (QUAD) Q3 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to today's call with Quad/Graphics' and LSC Communications. During today's call, all participants will be in a 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 this morning's earnings release. Alternatively, you can access the slide presentation on the Investors' section of the Quad/Graphics' website under the Events & Recent Presentations link and on LSC Communications website under the Events & Presentations link. Following today's presentation, the conference call will be opened for questions. [Operator Instructions] Please also note, today's event is being recorded. I would now like to turn the conference call over to Kyle Egan, Quad/Graphics' Director of Investor Relations and Assistant Treasurer. Kyle, please go ahead.

Thank you, operator, and good morning, everyone. With me today are Joel Quadracci, Quad/Graphics' Chairman, President and Chief Executive Officer; Tom Quinlan, LSC Communications Chairman, Chief Executive Officer and President; and Dave Honan, Quad/Graphics' Executive Vice President and Chief Financial Officer. Joel and Tom will lead off today's call with a detailed strategic overview of Quad/Graphics' definitive agreement to acquire LSC Communications. Dave will follow with a summary of the financial rational for the transaction and an overview of Quad's third quarter 2018 financial results followed by Q&A. I'd 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 3. Quad's 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, free cash flow conversion and debt leverage ratio. We have included in the slide presentation reconciliations of these non-GAAP financial measures to GAAP financial measures. On Slide 4 I'd like to remind everyone that information about the transaction discussed today will be available in the party's joint proxy statement. The information about parties who maybe participants in the process will also be available in the joint proxy statement. To be clear, this communication is not offered to sell or the solicitation of an operative by securities, it is also not the solicitation of a proxy from an investor or shareholder. Finally, a replay of the call and the slide presentation will be available on the Investor Section of Quad's and LSC's respective websites shortly after our call concludes today. I will now hand the call over to Joel.

Thank you, Kyle and good morning everyone. Today is a truly defining moment in Quad's 47-year journey. I am extremely pleased to announce our intent to acquire LSC Communications, a well-known and respected $3.9 billion leader in print and digital media solutions. LSC is a publicly-traded company on the New York Stock Exchange and has approximately 22,000 employees who served more than 3,000 retailers, catalogers, publishers and merchandisers from 46 manufacturing facilities and 13 distribution facilities in the United States and Mexico. With me today is Tom Quinlan, the Chairman and CEO and President of LSC Communications, and we look forward to walking you through the strategic rationale for Quad's acquisition of LSC and the opportunity it creates for all our key stakeholders. The combination of Quad and LSC Communications is a natural and strategic fit. Slide 7 provides a high level overview of the strategic and financial rationale for this transaction. Together with LSC Communications we will create a highly efficient print platform to fuel Quad 3.0, our strategy to create more value by leveraging our strong print foundation as part of a much larger, more robust integrated marketing solutions offering, deliver cost and time savings opportunities for our clients, maintain our long-term strategic vision by preserving my family's leadership and voting control in the company, generate synergies and additional free cash flow to create a more profitable combined company, and maintain our strong and healthy balance sheet from the all stock transactions structure. Each of these points will be expanded upon further throughout today's presentation. At this point, I'd like to pass the call over to Tom for his comments.

Thank you, Joel and I'm pleased to join Joel and his team to announce this exciting combination. Since LSC Communications became a standalone public company two years ago we have added critical scale, capabilities and technologies. We've done this through acquisitions and divesting assets and through tailing [ph] unique comprehensive supply chain solutions for our clients that address the root of their strategic needs. Additionally, we have established a strong logistics network and developed critical partnerships to help us revolutionize how our clients distribute content to all channels; this has all been done to strengthen our position as a leading innovative imprint and multi-channel logistics. Like Quad, LSC is an innovative customer first focused company. We share a commitment to challenging ourselves to do better tomorrow than we did yesterday. With Quad's integrated marketing solutions offering as a base this combination will build on and create new opportunities for our businesses including book, magazine, catalog, office products, logistics and pre-media [ph]. And with our investments in innovative solutions such as HarvestView and Intercept in companies like MAZ and StoryFit, we believe as one company we will be positioned at the forefront of a new age of content distribution and consumer engagement. We are pleased that LSC shareholders will benefit from the significant projected synergies in upside potential of the combined company. As we noted in the joint press release, we expect the combined company will deliver a broader client base for cross-selling and marketing outsourcing opportunities. The combined company will also have enhanced product production and distribution efficiencies and flexibility from the greatest scale of the combined complementary platforms supported by the printing industry's most experienced operators and innovators. In addition, the combined company will increase financial scale and a strong balance sheet. Before you turn the call back to Joel, I would like to thank the thousands of LSC Communications employees who work hard every day and execute so well on our strategy. Their dedication and unwavering commitment to our clients is the reason we are a leader today. I look forward to working with Joel and his team to ensure that the combined company is set up for success. And with that, I will turn it back over to Joel.

Thank you, Tom and I really appreciate you joining us today. Moving on to Slide 8; you will see a snapshot of the combined company's annual revenue for the 12 months ended September 30, 2018 of approximately $8 billion broken out by product and geography. The combination of Quad and LSC creates a compelling platform to better serve our clients utilizing magazines, catalogues, books, directories and retail inserts. These clients will benefit from significant cost and time saving opportunities in several different ways, enhance production and distribution efficiencies and flexibility from the greater scale of the complementary platforms, expanded logistics services in volume driven postage savings programs such as co-mailing backed by experienced and proven leadership, strengthened print management services and business process outsourcing; and for book publishers, specifically the strength of our combined platforms will create a truly end-to-end service offering that includes front-end workflow solutions, a large-scale state-of-the-art digital printing platform complemented by an extensive offset platform, and back-end integrated systems for finishing, distribution and fulfillment. Through this offering we intend to redefine the entire book supply chain providing book publishers with increased customization and versioning capabilities, faster time to market, and reduced waste in inventories and obsolescence. The acquisition of LSC Communications will strengthen our print platform to fuel our Quad 3.0 transformation. All product categories and geographies will benefit from our integrated marketing solutions, and with an expanded list of clients we will broaden our ability to help more retailers, marketers and publishers benefit from our expanded value proposition. The LSC acquisition is an all-stock transaction valued at approximately $1.4 billion including the refinancing of LSC's debt. We have structured the deals and all stock transaction to allow us to maintain our strong balance sheet and healthy credit profile for future capital deployment opportunities. Under the terms of the agreement, LSC shareholders will receive 0.625 shares of Quad Class A common stock for each LSC share they own representing approximately 29% total economic ownership and approximately 11% of the total voting power of the combined company. Based on the closing share prices of both companies on October 30, 2018, the merger consideration represents a premium of 34% to LSC Communications shareholders. Quad shareholders will continue to own Class A and Class B shares representing approximately 71% of the total economic ownership of the combined company and approximately 89% total voting power of the combined company. Post closure, my family will continue to have voting control at 70% which will provide us with continued stability and flexibility as we work to achieve our long-term strategic vision in a disrupted marketplace. Additionally, Quad will expand it's Board of Directors to include two members from LSC Communications existing board. The closing of this transaction is not contingent on financing and Quad has secured a financing commitment from JPMorgan Chase Bank. We expect the transaction to close in mid-2019 pending customary closing conditions including regulatory approval and the approval by both company's shareholders. When making a decision to acquire we take a disciplined approach and conduct a thorough review process to ensure there is a good strategic fit for Quad and our clients. The economics makes sense, the integrated plan is executable, and we can maintain the integrity of our strong balance sheet. The LSC Communications acquisition meets all these criteria and we believe it will create the opportunity for approximately $135 million in net synergies within less than two years through the elimination of duplicative functions, capacity rationalization, greater operational efficiencies, greater efficiencies in supply chain management that will also benefit our clients. We anticipate the significant level synergies will result in a more profitable combined company with a strong and healthy balance sheet. We are optimistic about the opportunity we have with LSC and the value it will deliver to our combined company shareholders, clients and employees. For those of you on the call who are new to the Quad story; I want to take a moment now to walk you through our history and go-forward strategy in the context of our announcement today. We described Quad's transformative journey in terms of evolutions with each successive evolution strategically building on the strengths of the previous one. Our growth strategy builds from our guiding purpose to create a better way for our clients, employees and shareholders. We do this by listening to our clients and evolving our offering to capitalize on opportunities that address their needs. In this way no single evolution replaces the next but layers on greater value for our clients across all product and service offerings. Quad 1.0 covered a period of tremendous organic growth that began with our company founding by my father, Harry V. Quadracci in 1971. During our first 40-year period, the company grew rapidly through greenfield growth. We built a premier manufacturing and distribution platform and established Quad/Graphics as one of the industry's foremost innovators with a strong company culture based on values that remain in place today. Quad 2.0 began in 2010 and continues today with our ongoing roles as a disciplined industry consolidator. We first saw an opportunity to participate in industry consolidation in response to economic and industry pressure followed by the -- following the Great Recession of 2008 and 2009 which severely impacted print volumes and accelerated the impact of media disruption. Through a series of consolidating acquisitions that included Worldcolor, Virtus Communications and Brown Printing; we added experienced talent, expanded our product offering, and consolidated our operations to remove inefficient and underutilized capacity and created the advanced highly automated and efficient manufacturing and distribution platform we have today. To make certain that we continue to drive productivity improvements into the future we have a strong and engaged workforce focused on maintaining our status as the industry's high-quality low cost producer This allows us to generate the earnings and cash flow necessary to support future value creating opportunities like the acquisition of LSC Communications. In Quad 3.0 we continue to leverage our strong print foundation built over the past 47 years as part of a much larger and more robust integrated marketing offering depicted on Slide 11. Today's marketers and content creators face significant media disruption, and they need a trusted partner who understands their business challenges and provides new ideas to help grow their business. We believe our print foundation which is a key component of media deployment is a true differentiator in our integrated offering. As a marketing solutions partner, we not only help our clients plan and produce programs but also physically execute and measure them across print and digital channels. Our integrated offering provides our clients with unmatched scale for onsite marketing services, integrated execution, and expanded subject matter expertise in digital, media and creative; this compelling value proposition allows us to remove the complexity our clients face when working with multiple agency partners and provides them with one integrated strategy that will help them reach their marketing goals. In doing so, we increase efficiencies through workflow re-engineering, content production and process optimization, and improve their overall marketing spend effectiveness through data driven insights and enhanced personalization leading to more real-time and actionable measurement. Key to our success in Quad 3.0 is our ability to expand our service offering to meet our client's evolving needs and make certain we have the appropriate resources and technology to scale in a significant way. To accomplish this, we take a disciplined build-partner-acquirer [ph] approach. In core strategic functions we hire marketing professionals with client side experience and build the capability from within. We partner with companies whose expertise helps us fill a specific gap or amplify our offering, and when we want to quickly scale to accelerate our transformation we acquire the company if the opportunity meets our disciplined acquisition criteria. So whether we build the capability internally, acquire the expertise externally or increase our investment in existing partnership, the result is a strategy centered on marketing solutions integration from understanding data insights, building strategy in developing creative to buying media and deploying content across all channels. In Quad 3.0 our expertise in planning and officially buying media on behalf of our clients has grown to $750 million and has expanded from traditional print to digital channels, and now includes TV and radio. To be clear, our acquisition of LSC Communications fits perfectly into the strategy and will further fuel our Quad 3.0 transformation to a marketing solutions partner and strengthen the role of print, a trusted media form. In Quad 3.0 we are redefining prints role in the highly competitive new media landscape, this combination will generate the earnings and cash flow necessary to support future value creating opportunities that strengthen our integrated marketing solutions offering. Upon closure, we look forward to welcoming LSC Communications employees to Quad where they will join a dynamic organization focused on growth and transformation with strong values based culture. Until then, it is business as usual, and we remain firmly focused on day-to-day production to ensure we meet our clients' needs and remain well positioned to succeed. I want to remind you that Quad has a proven track record of doing large scale integrations, and we are confident in our ability to deliver on synergies while continuing to execute on our Quad 3.0 transformation. Now I will turn the call over to Dave who will provide further detail on the financial rationale for the acquisition of LSC.

Thanks Joel, good morning everyone. We believe the acquisition of LSC Communications will create value for both company shareholders through significant synergies and strong free cash flow generation, as well as enhanced efficiencies and solutions for our clients from the greater scale of our complimentary platform. Slide 13 shows the expected synergies and their corresponding impact on the combined companies adjusted EBITDA. On a combined basis, 2018 pro forma adjusted EBITDA will be $650 million, the pro forma combined adjusted EBITDA increases by over 20% to $785 million when taken into consideration the one $135 million of potential synergies derived from this acquisition. A couple of items to note when looking at this level of post synergy adjusted EBITDA; first, we've excluded approximately $50 million of pension income from LSC's estimated $280 million of adjusted EBITDA at the midpoint of their new 2018 financial guidance. This adjustment was made to provide consistency with how Quad reports adjusted EBITDA which is without the benefit of non-cash pension income. Second, the $135 million of net synergies are an annualized estimate of the full run rate of synergies after we complete the integration which we estimate to take less than two years. The net result is a transaction that is accretive to earnings after excluding non-recurring integration costs, as well as substantial additional free cash flow. On Slide 14, we've summarized the key components of our anticipated net synergies of $135 million and the related cost to achieve these synergies. We expect to achieve approximately $60 million of synergies through capacity rationalization by optimizing the combined manufacturing and distribution platform. Another $50 million of synergies will be realized through administrative efficiencies such as SG&A savings, and another $25 million of approximate savings through supply chain management efficiencies. These synergies will lead to a stronger more diverse and more efficient company to better serve our clients. We have a proven track record of integrating consolidating acquisitions and anticipate achieving the net synergies within less than two years of the close of the transaction, we're confident in achieving our one-to-one synergy to cost ratio where every dollar of one-time cost to achieve that synergy leads to the annuity of $1 of an annualized synergies. Slide 15 illustrates the strength and efficiency of the combined free cash flow generation acquired in LSC. On a pre-synergy basis, the $650 million of combined pro forma adjusted EBITDA is expected to generate $295 million of free cash flow at the midpoint of both companies 2018 financial guidance; this represents an efficient free cash flow conversion rate of approximately 45%, or said another way, every dollar of adjusted EBITDA the combined companies generate results in $0.45 of free cash flow. This efficient generation of free cash flow will only improve as synergies are realized. We expect to deploy the significant level of pro forma free cash flow in several key ways. First, our annual dividend of a $1.20 per share represents only 30% of the total pre-synergy free cash flow or approximately $90 million after completion of the all-stock transaction. The remaining 70% or $205 million of pre-synergy free cash flow will help us retain the financial flexibility needed to strategically allocate and deploy capital as circumstances change. Initially, the two key priorities for capital deployment include debt reduction to maintain a strong and healthy balance sheet, and strategic investment in Quad 3.0 initiatives, both organically and through acquisitions. We will do this under the guide rails of operating within our long-term and consistent financial policy of maintaining a 2x to 2.5x leverage ratio. At times that leverage ratio may go above or below our targeted range due to the timing of compelling strategic investment opportunities such as the one we are speaking to today with the acquisition of LSC Communications and seasonal working capital needs. Slide 16 illustrates the deleveraging power of the $135 million of anticipated annualized synergies. We structured this acquisition as an all-stock transaction to maintain a strong balance sheet after the transaction is completed. From a pro forma leverage perspective which treats the acquisition as if it was completed on December 31, 2018, initial leverage would be 2.72x. When adding the deleveraging power of the synergies and the corresponding free cash flow generation that leverage declines to 2.43x. Note, the actual leverage will vary depending on the timing of the completion of the transaction, and the timing of synergies and the related cost to achieve. However, the pro forma leverage shows the directional trend for the anticipated lower leverage after synergies are realized. We do expect to be within our long-term targeted leverage range of 2x to 2.5x within two years of completing the acquisition. Quad has a long history of successfully integrating acquisitions; Slide 17 shows that history, as well as our ability to delever our balance sheet post-acquisition to be within our targeted 2x to 2,5x leverage range. Through each of these acquisitions we've refined and improved our integration process to create a structured and disciplined and long-lasting approach. We placed a strong focus on serving our clients well while we integrate the operations to improve the efficiency and productivity of our platform to expand products and services, and ultimately drive cost savings. This disciplined approach helps us maximize earnings and free cash flow and maintains a strong balance sheet while we grow the business. I'd now like to turn over in transition to our earnings for third quarter starting with Slide 19. We are pleased to report that our third quarter results were in line with our expectations and we remain on-track to achieve our full year 2018 financial guidance as narrowed on today's call. Net sales for the three months ended September 30 increased 2.4% to $1 billion reflecting the impact of the Ivie acquisition and Rise investments. As a reminder, Ivie and Rise are included in our financial results from the date of the respective acquisitions in the first quarter of 2018. Organic sales declined 3.2% after excluding a 4.6% positive impact from acquisition, and 1.6% positive impact from increased pass-through paper sales, partially offset by a 0.6% negative impact from foreign exchange. Both the quarter and year-to-date organic sales declines were due to ongoing print industry volume and pricing pressures, and are in line with our original 2018 annual sales guidance assumptions which included continued downward price pressures of 1% to 1.5% in organic volume declines of 1% to 4%. Adjusted EBITDA for the three months ended September 30 decreased to $8 million to $105 million as compared to $113 million in 2017 and our adjusted EBITDA declined to 10.2% compared to 11.2% in 2017. This one point decline in margins was due primarily to a 45 basis point impact from increased pass-through paper sales which represent a pass-through cost to our customers with the remainder of the margin decline due to continued print industry volume and pricing pressures. Our team continues to focus on proactively matching our cost structure to the realities of the top line pressures we face in the printing industry. Free cash flow of negative $38 million was in line with our expectations, this compares to $118 million of free cash flow in 2017. The year-over-year decrease was primarily due to expected timing differences from cash generated from working capital which concludes an intentional buildup of paper inventories in 2018 that will be reduced in the fourth quarter. As a reminder, we realized our strongest volumes in the back half of the year due to seasonality and as a result generate the majority of our free cash flow in the fourth quarter. On Slide 20 we've included a summary of our narrowed 2018 financial guidance. Full year 2018 net sales are expected to be approximately $4.2 billion, narrowed to the top end of our original guidance range. Full year 2018 adjusted EBITDA is expected to be in the range of $410 million to $430 million narrowed to the lower end of our initial guidance range, this reflects the additional investment we are making to increase hourly production wages in our most competitive labor markets. Unemployment is at historic lows and all industries are challenged to find quality entry level and skilled employees. Our labor strategy incorporates competitive wages, strong benefits and the necessary training programs needed to retain our employees and fill open positions. With these investments in our employees we anticipated a $10 million increase in our net cost structure in 2018. On an annualized basis we anticipate this investment in our employees will impact our net cost structure by approximately $25 million. 2018 free cash flow is expected to be approximately $200 million, narrowed to the lower end of our original guidance range due to the lower adjusted EBITDA I just walk through, and a $5 million increase in our capital expenditure guidance. The capital expenditure guidance included an increase due to additional investments we are making in our platform automation to drive further productivity improvements to help offset the impact of wage increases. All other components of cash flow guidance are shown on Slide 20. On Slide 21 you will see that our debt increased by $109 million since year-end to $1.1 billion due to $71 million of investments that we made at the acquisitions of Ivie and Rise, and $37 million of share repurchases. Our pension plan is 90% funded as of September 30 and our unfunded pension liability is $49 million. We've been able to reduce our pension liability by $35 million through our active management and de-risking our pension plan assets in a rising interest rate environment. Slide 22 includes a summary of our debt capital structure as of September 30. We finished the quarter with debt leverage of 2.46x and by the end of 2018 we expect our leverage ratio will decrease to approximately 2.05x or the low-end of our long-term targeted leverage range of 2x to 2.5x due to the anticipated strong fourth quarter free cash flow. Our debt capital structure is 58% fixed and 42% floating with an advantageous blended interest rate of 5.2%. We have no significant maturities until January 2021 and available liquidity under our $725 million revolver with $555 million as of September 30. We believe we have sufficient liquidity needs for our current business needs, investing in our business, pursuing future growth opportunities and returning value to our shareholders. As mentioned earlier, the acquisition of LSC has been structured as an all-stock deal to maintain the company's balance sheet strength post-acquisition and to provide liquidity and flexibility for future growth opportunities. Slide 23 shows our continued commitment to our dividend which is one of the ways in which we return value to our shareholders in addition to our share repurchase program. Our next quarterly dividend of $0.30 per share will be payable on December 7, 2018 to shareholders of record as of November 19, 2018. We've consistently paid a quarterly dividend and our annual dividend of $1.20 per share is yielding approximately 7% but only represents 30% of our free cash flow. We are in the midst of our seasonally busiest time of the year and we're focused on finishing the year strong and delivering on our 2018 financial guidance, that focus includes driving EBITDA enhancement and strong free cash flow generation by adding new business and continuing the focus on sustainable cost reductions and productivity improvements. Additionally, we are excited to take the next steps toward completing the acquisition of LSC Communications; a combination that we believe will strengthen our print platform to fuel our Quad 3.0 strategy and create greater value for our clients. The anticipated level of synergies is compelling and will drive growth in adjusted EBITDA and free cash flow to further strengthen our balance sheet and allow us to continue strategically deploying capital. Given our history, we are confident in our ability to execute well on this complex integration and create future value for all shareholders. And now I would like to turn the call back to our operator who will facilitate taking your questions. Jamie?

[Operator Instructions] Our first question today comes from James Clement from BRG.

Joel, first question, big picture; as you think about this integration process, you look back to Worldcolor, you look back to Virtus, you look back to Brown, all the other ones -- what were some of the lessons learned back then that give you confidence this one is going to be even more smoother sailing from an integration perspective?

I think you know that we're very process driven, everything we do has a process to it. You go through a massive integration like Worldcolor which was really a new twist for us in terms of switching gears and being an industry consolidator. There were -- there is a whole book of lessons that you learn through this, and each time that we've done another project we've applied those lessons to the next one. And I'll say that we feel really good about the process and the people that we have involved in this because as we've done these integrations you have to remember that were -- it's not just a couple of people doing it, we continue to build a whole team that's very deep, that knows how to deal with the process of integration. And that's why also -- I talked about our confidence, and also simultaneously executing on 3.0 because it's almost two different teams if you think about it. We have the people who know how to do this with our PMO Group combined with the structured approach that really allows this thing to operate like a machine when we're looking at integration, it's very data driven; and also we very much use our heart [ph] as we make tough decisions. And I think as we go forward, I think one thing you always learn is you can always go faster. And so in every successive one we've done, I think we've proven that we can pick up the pace as evidenced by the deleveraging nature of what we've been able to do, we couldn't do that unless we had a good process in place. And so I'd say that now more than ever I'm -- the most confident in the team and our ability to do this.

Obviously, their books business is certainly a relative strength, obviously you had the initial plan to buy Courier, RD [ph] came in above you; this makes you much, much bigger in books. Can you give us kind of your updated thoughts on how you view the books business and that sort of thing?

The book business is; I've always argued when disruption came along that that -- yes, there is digital disruption but I never believed that print would end up going into a massive freefall and I think it's being proven out overtime here. They have an outstanding book platform with an outstanding group of people, we've -- when we acquired Worldcolor, it's certainly a smaller business than what LSC has; and I have to tell you it was underinvested and we've taken the time to really ramp that up. And I think the big key here is the change in how both companies and the whole industry have approached the book industry, and that is -- it's digitally focused. We use our traditional print capacity but we've also built a whole capability as an industry to get rid of inventory for our clients and to be more customized. So as we've layered in the digital assets -- by the way one of the reasons we're so interested in Courier before my friend Tom snapped it away from me; thanks Tom. But it really is going to be I think a real powerful part of the story because I believe in this industry, but I also believe what we're bringing to our clients is very value-added and will help them manage the cost that they have outside of printing the books in terms of inventory, and time to market, and the ability to react quickly.

One of their business lines is something that you all have historically not had a presence in; it is -- are you committed to that business long-term or might you consider pealing that out at some point?

Well, look it is new to us but I will tell you if you go back to our other acquisitions, we've had a lot of new things come to us. In Virtus you wanted the big hidden gems was the media planning and placement business that we weren't in, and if you look at where we've taken that it's now -- we now buy over $750 million worth of media on behalf of our clients. We worked in in-store signage; now as we look at what 3.0 will drive in terms of the ability to drive more print, it's driving print into places we weren't before. Office products we don't know as a team -- I don't…

I didn't say office products Joel, I didn't mention that.

I thought you did.

I'm just kidding with you, I'm just kidding. Go ahead, sorry.

You're really funny. The office products business is something that LSC knows well, and it's been a good business for them. So as we kind of go down the road, we'll learn about it and we'll learn from them and we'll make our decisions on how it fits best. Tom, do you have any comments about the office products business? Do you want to…

No, thank you Joel. Look, I would tell you for the quarter the non-GAAP adjusted EBITDA margin, it was up 20 basis points to 13.1%. Obviously as Joel has talked about synergies, the team had office products as led by Jim [ph], he's done a great job as far as getting the synergy out of the acquisition that we did of quality park; we've been able to go ahead and increase private branded -- the mix of branded versus private label products sales, so that's been good. And again, we've been able to get forth -- cover ourselves on the manufacturing material increases that have taken place in the industry. So good team, good business, great customers; so that's always a good formula for a successful business.

Our next question comes from Dan Jacome from Sidoti & Company.

Can you talk a little bit first about the customer mix of LSC versus your customers mix just for the investors that are not too familiar with one company or the other? I think you guys are 53% catalog, magazine, insert and then LSC if I'm not mistaken, somewhere in the high-40s; just thinking long-term, how do you guys envision maybe customer mix to change or not change once fully integrated?

I think we have a great slide, Slide 8 or Page 8; it kind of breaks it out. But yes, I mean we're in a lot of the same lines of business and with the exception of what we just talked about in office products. And we will continue to really build on those because what you got to remember in one of the strengths of the combination but really the strength after 3.0 approach takes to this is that regardless of what business they're in, they are a marketer in one way shape or form. And all marketers today are under a lot of pressure because even though we've seen this whole advent of the whole digital strategy, the challenge in the big disruption that's happening today in marketing which is making 3.0 accelerate is the fact that it's not integrated, the digital media on it's own is not integrated. Our clients are really struggling with how do we pull this together, so we have one horizontal approach where we can measure what really works and use one measurement to go all the way across. And so depending on what product line you're in, you're a marketer; and to me that is an entry point for our relationship and our ability to add value to our clients in helping them run their business and getting rid of their pain points of this disruption. And I'm telling you the lack of integration is real, you're seeing the larger holding companies, ad agencies under a lot of stress because they're offering and how they help people market is not integrated. And for us we are a big invoice for any of these categories therefore we tend to have the C-suite relationships which allows us to start talking about this integration; and at first they don't see it coming but as we walk through it's a very logical thing for our customers to understand because we're embedded in their business with process. They manufacture the content, we execute on making it physical or dispensing it into other media channels; and so often times we're actually creating the content for them or a part of it. And I'll remind you that even today before this and before the expansion of the client roster, we have over 1,200 Quad employees in over 70 major marketing departments of large brands helping them execute on strategy. And so as we look at 3.0 and we look at the different categories of business that these two companies have, and even though a lot of it overlaps, it is an expansion of those opportunities to bring value add to our clients who are all looking for a solution.

Turning now to the debt; so I don't know if I missed it but did you guys -- you guided to a lot of the major metrics, obviously revenue free cash flow. Did you guide to what would be the combined company -- I mean I can back into it but the combined company interest expense last I checked -- I think LSC had blended interest rate that was just over 300 basis points higher than the 5% or so interest rate that you guys have. Any commentary there or it's just too early to tell?

Well, we will go through a process we disclosed in the press release this morning and mentioned in our script that we'll be refinancing the company -- the new combined company as we go forward; so we'll have more information coming out of that. Our hope is that the power of these combined synergies the result in free cash flow coming out of it; our focus on deleveraging the company we talked about, initially when you look at the end of the year leverage that we expect that based on the debt levels we expect at the end of the year to be above our long-term range but within two years it will be well within that range as the strong free cash flows come through the business. So more to come on that but I think directionally, the way to think of this business is it's going to be a deleveraging acquisition for us that allows us to create more capital opportunity for the very growth issues that Joel just walked you through. So it's absolutely fantastic acquisition to be able to expand our scale and opportunity and provide more capital for deployment that's going to result in share creation -- share value creation for our shareholders.

I didn't hear too much about the co-mailing; can you talk a little bit about LSCs versus yours and what sort of opportunities you guys might have done? And if I could sneak another one; can you also talk about the logistic businesses that LSC has been acquiring I think in the last 18 months? And how that might fit into your forward and long-term combined company strategy? Thank you very much.

I'll start, maybe Tom will chime-in on some of the logistics questions on his side but this is a really good question and a very key one to why this deal makes sense, especially for our clients. We are basically doing most of the work for the post office on behalf of our clients. Back in 1991 the post office started a work share program that allowed customers to get huge discounts, and for those who don't know, over 60% of our customers cost is postage, print tends to be 20% or less with paper being the rest of it. And so our ability to merge clients together we're all a big co-op of clients using our equipment, and the printer's ability to pull that volume together really determines how much we can actually save for them and if we can reach the full potential of the post office. Now while I'm a huge believer in print, everyone knows that we've been experiencing fairly significant decline over the past decade, and that decline puts pressure on both company's ability to execute in co-mail for our customers. And so one of the big reasons this makes so much sense is to shore-up the ability to continue to offset one of the biggest costs for our clients on a go-forward basis. And so Tom and his group have done a wonderful job over the years of developing very aggressive and capable co-mailing services just as we have. But the truth remains that we have to continue to shore-up to make sure that print has a place at the table in the marketing mix which in some of this disruption lost it's place at the table and 3.0 is bringing it back.

Joel nailed it. I mean the job in addition to creating value for our clients is also to mitigate expenses, the manufacture materials continue to go up. How can we mitigate those? As Joel said, the distribution costs continue to rise. You look at what we did with Farrington Clark in [indiscernible]; we're attacking mail newsstand and e-commerce, so with our footprint that we've got from a warehouse standpoint it's going to allow this new entity to even get into e-commerce -- distribution of e-commerce more outside of physical content if you think about where Quad 3.0 is headed, all of those -- what I'll call retailers are going to need someone to go ahead and distribute their content or in fact their product. So how can we do that better for them? The USPS is still a main component of our cost structure, having the co-mail capabilities and [indiscernible]. Literally our industry helps the USPS take the content and have it form in a tray so that they can just put it on their truck and head out and deliver it. Those efficiencies are going to get even better for everyone, so a lot of opportunities as Joel talked about Virtus -- logistics is going to bring a lot of opportunities, Newsstand is a tough place right now but we think we'll bring it forward on from a newsstand standpoint, we're going to help the newsstand.

And some of those services that Tom has done are not only complementary but some of them will expand our services, and so we're very much looking forward to that. He's done a lot of things on the book side from a fulfillment distribution standpoint, and I'm sure we're going to learn more of that and we're only going to enhance.

I think you said you expected to be fully integrated by early next year. That looks -- I guess I'm just going back to Jamie's terrific question on just past acquisitions; I mean what gives you confidence given the scale of the acquisition – merger, I should say that there will be no customer disruptions. Was there anything in the past acquisitions maybe with the World Book [ph] that -- momentarily there was some customer issues or disruptions? I'm just trying to think about the risks over the next six months because it is such a large acquisition.

Dan, just to correct on that what we said is post-closing we expect to achieve these synergies within two years. So the early next year comment, that's a little bit off in time. We're going to -- and then within new year's get there. It is not a light switch where we're just turning on this integration process if -- it bothered us over the past, what we've had a strong project management office solely focused on EBITDA enhancement in our business in which we every year geared towards taking out $60 million of cost, that's the same team that's going to work on this integration combined with the strong leaders over at LSC to take advantage of the opportunities that are out there to drive these synergies.

In terms of the customer thing, that is -- like the most crucial part of an integration because moving customers from one plan to another in a -- and we're basically a job shop where no two publications are the same month after month; very process oriented, and so we're very proud that when we've done this we have actually retained an extremely high percent in the high 90's of our clients because of the lack of disruption. Again, it goes back to our ability to have a lot of visibility into the platform with a strong IT platform but also the process driven. And so I think we're going to need to move to the next caller Dan, but thank you for your questions.

Our next question comes from Charles Strauzer [ph] from CJS Securities.

Tom or Joel, maybe both of you can share this question -- just looking near-term here, kind of the updated guidance for both companies; Tom you took down EBITDA guidance but basically kept revenue guidance intact, it seems that margins are under pressure there. While Joel, your margin seems to be holding up much better than Tom's, maybe the two of you can kind of share thoughts on the dynamics behind that?

Joel, I'll take it and turn it over to you. I think -- look, we expected obviously from our last call at third quarter than what we showed you today. And I think as you look at the margins, logistics acquisition plays in that, there was about 60 basis points. When you think about the tight labor market conditions that we saw in the third quarter, we know they're going to continue in the fourth quarter or they're going to result in higher wages. We are not as automated, probably as Quad is; and that leads to lower productivity, so I think -- actually the combination of our two companies will help not only in the automation and productivity but the industry as a whole in every product line as you think about it. Book mix was solid, the amount of book work that we have is -- continues to exceed my expectations which is great, and I think as we look at '19, early indications from our clients are that '19 is going to be a real good year from a book standpoint. So getting our abduction [ph] order from a productivity standpoint will help our business, help their business and then when the combination gets together, I think there is some really good opportunities there.

And I'd just add to it Tom, that -- everyone's dealing with the loan employment environment right now, it's at 50-year low or whatever it is. And that puts a lot of pressure on -- in fact, one of the things that I think is helping us is we just invested in our employees with big increase in starting ways just to be able to build the pipeline. We're really attacking from an innovation standpoint of how do we create band services for intercity opportunities for talent that are looking for jobs; so it's definitely one of those things that we're all faced with but I think we're managing it well, but I'll also say that the 3.0 strategy is contributing to how we're doing. I mean last year we shared with you that we've created over $150 million in incremental revenue that goes across all product lines which by the way further proves to everyone that it's not just the 3.0 revenue, the 3.0 services actually drives down into print whether it's packaging and store, direct mail and commercial; it's affecting all products, it's actually a print creator as opposed to something else. And so that's where I want to make sure that people understand that this is a stack of services and products that all work together. And also the industry has been under a lot of pressure, and so that's why I mean the challenges that are out there makes this deal -- makes so much sense is we have to be able to rationalize the platform but most importantly, make sure we've got the right talent in the right places to really execute for our clients.

And then Joel, obviously the industry pressures you mentioned, it's a good segue for my next question which is basically just on the regulatory approvals and potential hurdles there. Do you foresee any material hurdles as they're getting in the way of approval here?

Look, I think one of the big obvious things going on here is that while we struggle with volume declines that marketing revenue is going somewhere. If it's coming out of print it's been going to all media channels, and I think you probably have to be living under a rock in the last decade if you don't see that our real competition is other channels. And you know, I'm a big believer that print is going to -- it is a part of it and is not going to go away but the amount of revenue that's -- or the amount of spend that marketers have that has been shifted to all these different channels is immense. And so I think at this point in time it would be hard for someone to make the case that our competition is not other forms of media. I'll also say that the acquisition is great for customers from the standpoint of our ability to offset distribution costs but more importantly, it will allow me with the free cash flows this thing creates to keep investing in them. They need me to invest in the print platform to be able to offset the challenges and make print continue to have print be a part of it; and that's not just by only just being more efficient, it's also by creating more value. So if we start converting customers who used to only do catalogues to direct mail but not dumb direct mail -- I'm talking direct mail don't at digital presses where all the content is completely variable based on what just happened yesterday online, you know, if that creates revenue and margin for us but also reduces our customers marketing cost because it's not about cost per piece, it's about cost per response. And so if they're spending more on value add because they want to do data driven marketing which is really what we're talking about, that ability to do it is super important; and so the acquisition from making sense in what we have to pull-through on the regulatory side I believe is so important to our clients. We have significant synergies that come out of this, and that's always important because that means that you're helping with the whole cost factor. And I think that I'd love -- you have to look at the printing industry, it's still a huge $70 billion industry with lots of competitors but there is also lots of technologies coming out. So I'm really excited about our digital printing capabilities like in the book market; guess what, Amazon's printing books too, and they will continue to grow that. The barrier to entry on some of these technologies while I think that our overall strategy on being able to execute on them are very good, the barrier to entry on the digital printing press lowers the challenge of getting into it. And so I think there are so many things that line up here that make this a very solid case with the regulators.

Our next question comes from Bill [ph] from Baird & Company.

A question for Dave and Dave when you talked about refinancing the LSC debt which carries a high coupon, the senior secured -- how are you thinking about that? Are you thinking you're going to wait until the next call date in October or are you going to pay a small premium -- make whole [ph] premium and take that out maybe when the transaction closes right around mid-year?

That's a great question. And I think when you've known Quad, if you follow Quad we're very much a company that likes to be transparent but also deal with risks that are currently present. And when we look at the refinancing, we've had a history of playing in a lot of deep and diverse debt markets, we've got very strong in support of bank group, we've had term loan B market with high yield, and even in the private placement market as we were growing as a private company. So there is a lot of markets we like to look at here, and we're also going to balance that against as we see taking market risk off the table as things come about. So I think you'll see a thick action fairly quickly but will also be wise as kind of look at what's going on with the markets. But we'll have -- we'll be launching our refinancing fairly soon with our bank markets and they are making a decision beyond that which other markets will play-in but we'll probably do that fairly quickly.

And then one question which -- I'm not sure really relates to the acquisition but I'd be interested in hearing your thoughts, both Joel and Tom with some of the troubles in the retail industry, obviously Bon-Ton, Toys R Us, most recently Sears, and JCPenney appears to be a little bit on the brink. How much of an impact has that had on your business or has it been a benefit because they're looking to basically outsource those services in an effort to go ahead and preserve cash flow?

Well, it's been both; it's been a negative impact and a positive one. Negative from when someone goes away, the volume goes away but back to my point that -- not just retailers, all marketers are under a lot of pressure and they're all trying to figure out the multi-channel mix. And so what we're finding is a much more receptive conversation about 3.0 with those clients, and willing to act faster; so that's all a good thing. But I'll tell you there is a basically a bifurcation going on in the retail experience when you think about brick-and-mortar, and it's very simple. If it's a bad experience you're in trouble, if you figured out how to make it a good experience and that you figured out how to leverage multi-channel you're going to do well. And I think everyone is calling for a pretty strong robust retail season here but long-term you're seeing the multi-channel thing try and seek it's correct water level, and people are figuring out how to compete against the Amazon's of this world. But again, it's going to be about does your customer like the experience or not? And Tom, I don't know if you have some other comments?

Thank you, Joel. And look, understand as you think about our two platforms. Our percentage in what I call retail inserts is not that large. So I think as we look at it, I think what Joel said is spot on again; that the multi-channel approach what retail is trying to figure it out -- they're going to continue to look for ways to get their content to their customers; you think about what we've invest in a company called Mask [ph], they basically can take content in any form and convert it into any Social Media outlet over any device. I mean it's -- there is tremendous amount of ways that are changing the way content is being distributed, and I think having the approach of having a Quad 3.0 allows customers, clients to avail themselves to those ways as they try to figure out which way is this that they need to connect with their end customer. So as always, lots of opportunities when you get to situations like this.

Our next question comes from Anthony [ph] from Citi. Please go ahead with your question.

This is actually Brian Burke Myer [ph] sitting in for Anthony, thanks for taking the question. Understanding you're still in the early stages, do you see the potential for any working capital synergies either through improved inventory efficiency or improved like payable-receivable terms?

I do think there is, we haven't quantified that at this point. However, with the scale and the combination of these two companies, I think that provides opportunities as we kind of look at it as one process versus two process across two companies. We focused a lot in the past on working capital, it's part of the reason why you saw the decline this year versus last year because we kind of completed a lot of the benefits of a process improvement program we've done through a lean enterprise, efficiency program for working capital which we were able to reduce our days of billing outstanding from call it close to two weeks to one day; and that generated a lot of free cash flow for us over the past several years, and now we're kind of analyzing on those numbers. I think -- those types of projects where you can bring lead enterprise across two company and really combine the processes into one I think are going to provide opportunity for us, and we'll continue to assess that as we get to know kind of the processes of LSC and how those are the same or different than Quad. So I think there is opportunity for us in the working capital side as we look forward to this transaction.

And our last question comes from Jamie Clement from BRG as a follow-up.

Tom, in the logistics and co-mail PC business, I guess -- my understanding is Quad's got a lot more trucks than you guys did, and overtime obviously think you'd be able to pass along, increased spot rate, purchase transportation to your customers; but have you been eating a little bit of that like here in the third quarter?

Not really, not too much. I mean look the hurricanes that the country's endured really haven't been that big of an impact on the cost of transportation. So I would say no, that usually hasn't been the driver. I mean, obviously driver shortage and cost of fuel impact everything but I would say we've managed through it pretty well.

So thank you all for joining us today, sort of in closing here. As people digest all the information here, please know that both teams, the Quad team and the LSC team are available to answer your questions offline as we always are. To the LSC employees, I want you to understand that I very much look forward to you joining our team. I think you'll find us to be a very down to earth manufacturing centric company, with approach based on the values that were created by my father that will only enhance your experience in my -- with us as part of the team. To the Quad employees, thank you, all the work that you have done over the many years has allowed us to take advantage of this opportunity to acquire such a storied name with LSC, and it's long legacy of being one of these companies as I was growing up as a kid that my father always pointed to as part of R.R. Donnelly, the original R.R. Donnelly, that we always wanted to be like. And we could not have done this unless the innovation, the hard work, and building our culture, our team on the floor and in all parts of our company have done. So with that, thank you all for joining us.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.