Quad/Graphics Inc (QUAD) 2011 Q2 法說會逐字稿

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Quad/Graphics second-quarter 2011 conference call. During today's call, all parties will be in a listen-only mode. Following the speaker's presentation the conference call will be open for questions. (Operator Instructions) I would now like to turn the conference call over to Barb Bolens, Assistant Treasure and Director of Investor Relations for Quad/Graphics, please go ahead.

Thank you operator and good morning, everyone. With me today are Joel Quadracci, Quad/Graphics' Chairman, President, and Chief Executive Officer; and John Fowler, Quad/Graphics' Executive Vice President and Chief Financial Officer.

Joel will lead off today with a review of the financial and operational results for the quarter, provide an update of World Color integration activities, discuss headwinds in the marketplace, as well as highlights in the quarter and also discuss our strategic priorities both for the quarter and going forward, including how we look at investments in print.

Following Joel's remarks, John Fowler will provide a more detailed review of the second-quarter financial results, the financial progress we have made on the integration, as well as an overview of the Transcontinental and refinancing transactions announced in July.

We will continue to make comparisons to the pro forma Company for second quarter 2010. Following John's update Joel will conclude with an overview of our key priorities for the remainder of 2011. I would like to remind everyone that this call is being webcast and forward-looking statements are subject to Safe Harbor provisions outlined in our quarterly news release and slide presentation that are both posted on our website.

The slide presentation can be accessed through a link on the investor relations section of the Quad/Graphics website at www.qg.com. There are also detailed instructions on how to access the slide presentation in our second-quarter earnings press release issued last evening.

A replay of the call will also be posted on the investor relations section of the website after the live call concludes. I will now turn the call over to Joel.

Thanks Barb and good morning, everyone. For the second quarter both net sales and adjusted EBITDA met our plan. Net sales were $1.07 billion, roughly flat to the second quarter of 2010. Aggressive pricing in the industry, contracts inherited with the acquisition and a decline in the book segment, negatively impacted net sales while paper and by-products increases, non-perk revenues, which are primarily logistics and foreign currency translation provided a positive impact.

Adjusted EBITDA to $126.7 million also met our plan, with an adjusted EBITDA margin at 11.8%. However, both were down from the second quarter of 2010. As we discussed in our last quarter call, we knew that the first half and specifically the second quarter of World Color's 2010 adjusted EBITDA results were at unsustainably high levels of profitability due to temporary cost reductions taken while in bankruptcy and would provide challenging comparisons to 2011. We believe that is important to note when making comparisons to the second quarter.

Volumes were better than expected, and should have resulted in beating our plan. However, continuing frictional costs in the plants that have absorbed the greatest increases in titles and volumes from the integration lead to a higher cost of sales. Putting this in perspective, plants that had received work from closed facilities produced on average almost 30% more print volume in the first half of 2011 versus the same period in 2010.

The majority of this increase was due to the work moved from closed facilities and resulted in hundreds of new hires, significant training of new teams, and a slower ramp up of productivity. We are confident these frictional costs are temporary and have resulted from this very complex integration and I am pleased with the continued focus our employees have had on ensuring we are meeting or exceeding our customers expectations through this period.

We also continue to experience pricing headwinds in the market due to over-capacity in the industry, as well as the contractual pricing we inherited at acquisition. Other impacts include the reduction in net sales in the book segment. As well as higher paper sales sold at lower margin than print sales. We continue to be successful in achieving synergies which offset a portion of the EBITDA impacts.

Despite these short-term challenges, we continue to feel very good about the progress we are making on the integration of World Color. We have just passed 1 year milestone and have made tremendous progress, completing the shutdown of 9 of the 10 plants announced for closure, and reducing workforce by net 3,400 full-time equal employees since close. We've moved equipment and titles from less productive plants into more efficient platforms and have achieved approximately $120 million in synergies in the first 12 months of the integration.

To clarify what we include in synergies. They are costs savings that we have realized as a result of the combination of the 2 companies, our normal cost reduction efforts in the Business would not be included in synergies since they are not related to the Company's combining.

We are pleased with our progress to date and very excited about the platform we are creating. We continue to be confident that we will achieve more than $225 million in synergies we initially projected and will update that number as we progress through the second 12 months of integration. There is still a lot of work ahead of us, before we can say we are done. But, we are pleased with where we are today.

We have faced several headwinds in the market during the quarter, including continued aggressive pricing in the North American print market, declines in revenue in the book segment of our Business, and a softening global economy. From the pricing perspective, we continue to be in challenged pricing environment and believe that we are better positioned to endure the price decline than most. However, in the near-term, we need to work even harder to offset these pricing declines through cost reduction, synergy achievement and productivity improvements.

Within the book segment, we saw declines in net sales in the quarter as a result of the changing dynamics in the retail channel. There are very visual structural changes occurring in the book distribution model, as Borders' bankruptcy and subsequent liquidation caused a disruption in the channel and impacted our net sales.

Publishers are also seeing a mix change from hard-cover to soft-cover books as well as a greater demand for shorter runs and digital print technology. The industry is changing rapidly and we will continue to make the necessary and desired investments, including highly advanced digital printing capabilities for shorter runs and print on demand.

Although books will continue to face challenges, understand that books accounted for only approximately 7% of revenues in the last 12 months. Clearly the economy has been the center of much of the news lately. The recovery we have seen to date is at best fragile and we have seen signs of softening economy with recent downward revisions in GDP, declines in consumer spending for the first time since the recovery was in its early stages, and an unemployment at naggingly high levels.

We believe we began to feel the effects of the softening economy in June, trends which continued into July. We are watching the economy closely for how it may impact us in the future.

As we spoke last quarter, we are balancing our time as a Management team between our focus on World Color integration as well as planning and executing our strategic growth initiatives. One the first visible signs as how we're looking at positioning Quad for the future, and strategically managing our portfolio was the Transcontinental transactions announced in July.

Essentially, we will be exchanging our Canadian assets, excluding the Vancouver plant for Transcontinental's Mexican assets. Transcontinental will also assume approximate $75 million in pension and post-retirement liabilities. The transaction expands our presence in Mexico, where there is a growing middle class, a population more than 3 times the size of Canada. And an economic growth rate projected to be in excess of 4.5%. Which are all characteristics that are generally favorable for print growth.

In the Canadian market, we face a lower growth economy, and a highly competitive print market with excess capacity. Our forecasts project continued sales and adjusted EBITDA declines into 2012 and we needed to make significant investments in our platform just to maintain current levels of profitability.

We expect the transaction to be accretive to value immediately with Transcontinental's assumption of the pension and post-retirement liability and to create positive incremental adjusted EBITDA within 12 to 24 months following the close. John will walk through the economics of the transaction shortly.

As we look at strategic growth opportunities for the future, we take a very realistic look at our industry, both in the US and internationally. In the US, we believe that print continues to play a very relevant roll in multi-level marketing strategy and focus with our customers is to help them to maximize the effectiveness of their advertising, print and distribution dollars using all channels.

Industry data we watch confirms that print in our core markets of magazines and catalogs continues to hold fairly steady since coming off the significant advertising declines in 2008 and 2009. This is true in both total magazine circulation, as well as catalogs mailed.

As we assess deployment of capital, we look strategically at each investment and how it creates value for our shareholders. In mature stable markets where there may be consolidation opportunities such as World Color, we assess value based on free cash flow generation. In higher growth markets and adjacencies we look at profitable growth in markets where we can leverage our core competencies. We believe there are opportunities to create value in print.

We continue our dividend policy that we initiated in May and yesterday announced our next quarterly dividend of $0.20 per share which will be paid on September 9, 2011, for shareholders of record as of August 29, 2011.

The progress we are making on de-risking our balance sheet as we continue to reduce both debt outstanding and pension liabilities allowed us to take advantage of the improvement in credit markets with a successful debt refinancing that closed several weeks ago.

Looking forward, we believe that our improved credit metrics coupled with our conservative financial policy and leverage targets will serve us well if the economy does continue to soften. John will discuss the refinancing in more detail in his financial review.

What is significant about our accomplishments in the quarter is that we signed the Transcontinental transactions as well as completed the debt refinancing without disruptions to the team involved with the integration as a result of the depth and talent in our organization. While during the quarter we continue to experience temporary frictional costs, we continue to be confident that these will subside as we move closer to completing the integration.

We also remain confident in our ability to leverage Quad's core competencies to drive profitable growth in the Business. Our economy remains fragile and uncertain, however, our Management team is focused on positioning or Business for the future and influencing what is under our control. I will now turn the call over to John who will present the financial review.

Thanks, Joel and welcome everyone. Before I start the overview, please remember that the comparisons we make to the prior year will be to the pro forma combined Company for second quarter 2010, as we believe this is the most relevant comparison.

Slide 14 is a snapshot of the second-quarter financial results compared to the second quarter 2010 pro forma results. As Joel mentioned sales were roughly flat last year second quarter at $1.07 billion. Cost of sales at $832 million was 1.8% higher than second quarter 2010.

SG&A expense of $112 million was up very slightly from $111 million in 2010. I will review the drivers of both cost of sales and SG&A that had material impacts to adjusted EBITDA in a bridge I will walk through shortly.

Depreciation and amortization was $87.7 million, and interest expense was $29.5 million. Recurring free cash flow, which we define as cash flow from operating activities, less CapEx, and excluding non-recurring items such as restructuring cost was $114.4 million through the first 6 months of the year.

While this is the first time we have spoken about free cash flow on our calls, we believe this is an important metric for us as we expect our Business will generate significant free cash flow which we can use to invest in and profitably grow our Business. We have provided a reconciliation of recurring free cash flow for the 6 months ended June 30, 2011, in our slide presentation.

To try to quantify the impacts in the quarter and provide more clarity to our financial statements, we have put together the following bridge on the impacts to adjusted EBITDA. The positive impact in the quarter, includes the synergies achieved, which were $34 million in the second quarter, and approximately $120 million in the first 12 months of integration.

Offsetting that impact was frictional costs, which although not specifically quantifiable, are estimated to be in the range of $20 million to $25 million. Pricing decreases of approximately $16 million, $5 million due to the decline in the net sales in the book segment and $10 million to $15 million of other net impacts.

Please note that some of these figures, especially the frictional costs are estimates. But our goal is to provide clarity not only to the impacts on our Business today, but also going forward.

We believe we have been very effective in off-setting the pricing declines in the industry through the achievement of synergies but we need to continue to be diligent in increasing productivity and operational efficiency. As we progress through the second 12 months of integration, frictional costs are a focus of the integration and will gradually subside. However we do expect them to be felt in our cost structure throughout the next year.

Slide 17 shows a reconciliation of the $23.4 million in restructuring, impairment, and transaction-related charges for the quarter. Integration costs were $8.9 million, other restructuring costs which include cost to maintain and exit idle facilities, as well as lease-exit charges totaled $8.4 million. And employee terminations costs were $5.1 million.

When comparing the second quarter 2011 restructuring versus 2010, keep in mind that 2010 was higher, due to the large restructuring we'd undertaken in our Poland facilities as well as some larger restructuring costs taken by World Color in the quarter prior to close.

I'd like to spend a few minutes discussing the Transcontinental Mexican acquisition and Canadian divestiture transactions we announced in July. We have summarized the transaction projections on Slides 19 and 20. As we explained in our news release and subsequent 8-K filing we will be acquiring the Mexican assets of Transcontinental. Transcontinental will take on Quad's Canadian operations excluding our Vancouver plant and will assume approximately $75 million of pension obligations. It is important to understand how Quad believes it will create value in this transaction.

On a post-synergy basis, so within 12 to 24 months following close, we expect the combined Mexican business will generate forecasted pro forma net sales of approximately $115 million and adjusted EBITDA of $20 million to $25 million. We expect that the investment needed for both CapEx and other expenses required to combine the Businesses will be in the $20 million to $25 million range.

In Canada, while we are projecting $310 million in net sales and $25 million in adjusted EBITDA in 2011, our 2012 projections were for approximately $220 million to $250 million in net sales, and $12 million to $16 million in adjusted EBITDA, and applied adjusted EBITDA margin of 5% to 7%.

To achieve that level of EBITDA in 2012, our planned investment was $15 million. To return to 2011 adjusted EBITDA levels, the total investment required would be $40 million to $45 million. Incremental to this investment would have been the capital required to fund the pension liability being assumed by Transcontinental.

This is all in the backdrop of a slower growth economy, in a very competitive print market, with excess capacity. To us, this was a very compelling financial and strategic decision. It will add value immediately through Transcontinental's assumption of the $75 million in pension and post-retirement liability, and we expect incremental positive adjusted EBITDA within 12 to 24 months of closing.

As reported net loss in the second quarter of 2011 was $10.3 million, or $0.22 per diluted share, as compared to an as reported net loss of $35.7 million or $1.27 per diluted share in 2010. Excluding the effects of restructuring, impairment and transactional related charges in both years, net earnings were $5.8 million or $0.12 per diluted share in second quarter of 2011, as compared to an as reported net loss of $2.9 million or $0.10 per diluted share in 2010.

Slide 22 is our summarized balance sheet as of June 30. Our book equity is approximately $1.5 billion and the reduced leverage in our balance sheet combined with the strength in the credit markets allowed us to complete our recent debt refinancing very successfully.

Reducing the risk associated with the pension and post-retirement liability has been a key objective of ours. As of June 30, 2011, our pension, MEP and post-retirement benefit liabilities have decreased by $145 million, since the close of the transaction when the balance was $547 million.

We recently learned the last of the labor unions that had not approved the exit of the MEPS voted in favor of doing so. Which means we can now proceed with plannings for the complete exit from the MEPS and expect that to occur sometime in 2012.

Based on expected pension funding in 2011 and 2012, paying the cost of exiting the MEPS in 2012 and Transcontinental's assumption of Canadian pension liability, we believe that by the end of 2012 our pension and post-retirement liability will be reduced to only $160 million to $200 million. This represents a major accomplishment in reducing both the risk on our balance sheet as well as returning to Quad's strategy of providing pay-as-you-go benefits to all of our employees.

Slide 23 shows a snapshot of our cash, debt, and leverage ratios as of June 30, 2011. Since the close of the transaction, we have reduced net debt by $233 million. Our interest coverage ratio is 5.3 times, and our leverage ratio is 2.4 times. We will continue to operate in the 2.0 to 2.5 times leverage range as we believe that is the appropriate amount of leverage for a Company like Quad.

At times we may go above or below that temporarily, given working capital seasonality, timing of investments and growth opportunities. As Joel mentioned, we believe our conservative leverage profile and investment grade metrics will service us very well if the economy softens further.

We announced several weeks the very successful conclusion of our debt refinancing. We are very pleased with the outcome and I'd like to provide a brief summary of our new financing package. Our decision to enter the market was driven by the combination of our improved balance sheet metrics since the close of the acquisition, as well as the improvement in the credit markets.

This refinancing allowed us to achieve increased flexibility, increased borrowing capacity under our revolver, and a cash interest savings of $16 million to $20 million annually, among other benefits. We have also extended our maturities as the revolver and term loan A have a 5-year maturity and the term loan B has a 7-year maturity.

The marketing of our debt went extremely well and was substantially over-subscribed, thanks to the initial support of our 5-book running banks, JPMorgan, Banc of America, US Bank, PNC and SunTrust, with commitments totaling $900 million, the great support of our other lending banks as well as the institutional term loan B market.

This greater demand allowed us to reduce the original issue discount and the LIBOR floor on the term loan B, as well as increase the size of the revolving credit facility. The final structure of the refinancing is $1.5 billion in total and $850 million 5-year revolving line of credit, a $450 million 5-year term loan A, and a $200 million 7-year term loan B. Our availability under the new revolver was $644 million at the close of the refinancing.

I would like to especially thank our internal team, which includes Kelly Vanderboon, our Vice President and Treasure, and Barb Bolens and many others on the their work on this successful offering.

As of the close of the refinancing, borrowings under our new $850 million revolver were $170 million at a rate of 2.4%. This is down from 3.4%. The blended interest rate on the total debt balance is 4.9%, which is down from 6.1%. And the outstanding principal balances are 57% floating and 43% fixed.

Long-term fixed-rate debt consisting of private placement notes continues to be at an average interest rate of 7.5%, has an average maturity of 11 years with a weighted average life of 6.5 years. Our floating rate debt today is at an average rate of 2.9%, which is down from 5.1% prior to the refinancing. Given the increased flexibility under our new revolver, we believe we have sufficient liquidity for both current Business needs and future investments.

Today we have tried to layout clearly and consistently the various factors affecting our financial results. We have been very successful to date at achieving synergies through the progress we have made in integration, but it has been needed to offset the intense price competition that exists in our market as well as some of the cost re-sets from contracts we inherited with the World Color acquisition and the frictional costs we are incurring during the integration.

As we turn to our outlook and financial projections for 2011, we come into the back half of the year having achieved our plan to date. In fact, volumes in the second quarter should have resulted in us beating our plan, had we not incurred the level of frictional costs in the quarter.

We remain committed to achieving our full-year projections of adjusted EBITDA being slightly in excess of $700 million. But, given the softness we saw in the economy and reflected in our volumes in June and July, the headwinds we see from the revenue decline in the book segment and the lingering frictional costs we are incurring, we believe it's prudent to adjust our full-year projection to a range of $660 million to $700 million. The projection excludes any impact from the transactions with Transcontinental.

This range should result in $260 million to $300 million in recurring free cash flow for the year after pension payments of $61 million. Additionally, we continue to expect depreciation and amortization to be in the range of $345 million to $365 million, interest expense to be $105 million to $110 million, capital expenditures to be $170 million to $200 million, and cash taxes to be less than $10 million.

We intend to continue to be diligent stewards of shareholders' capital, and very deliberate as we allocate capital between profitable growth, deleveraging, and returns to our shareholders. I would now like to turn the call back to Joel, who will provide some concluding remarks.

Thanks, John. As we have passed the 1-year milestone for closing the World Color acquisition, I'm very pleased with the progress we have made to date and am confident in our team's ability to successfully complete this very complex integration. I am proud of the focus that our employees have maintained to ensure we are meeting or exceeding our customer's expectations.

I talked last quarter about being operationally impatient to achieve results, but this is strategically disciplined when it comes to planning and executing our path forward. That continues today, and we were excited to announce both transactions with Transcontinental, as well as the debt refinancing, as I view both of these has having tremendous strategic value to Quad/Graphics as we move the Business forward.

For the remainder of the year our focus remains to serve customers seamlessly, achieve synergies, improve productivity and reduce our costs to offset pricing pressures. We will also explore profitable growth opportunities that will strengthen Quad's market position, expand our capabilities for customers and create value for shareholders.

Most of these areas of focus have been goals for the Quad team for many years and have been the key to our success and they will continue to be our goals into the future. That concludes our prepared remarks. Operator, we are now ready for questions.

(Operator Instructions) Scott Cuthbertson.

Thanks a lot for the improved disclosure here. It's really helpful. Just turning to Slide 16 for a second, which I find quite instructive. I'm just kind of wondering how we can think about the second half of the year, Does this represent some kind of a run rate or what can we take from, from this, just EBITDA bridge presentation and in terms of what we can model going forward?

Hi, Scott, this is John.

John.

I think, I think you can kind of do the math that we've indicated that we've achieved $120 million of synergies in the 12 months and $34 million into the quarter. 1 of the keys for us Scott, like other printers, a majority of our earnings and our heaviest volume is in the second half of the year, so there's a lot of leverage that we have going into the second half of the year. So don't think that there is anything here that is going to necessarily be unique to the quarter versus what we're going to see in the second half. Clearly with the frictional costs at $20 million to $25 million, that's major focus of our Management team here. The focus on what we can accomplish with that, it does, it is challenged in the second half of the year that you've got a lot of work, but it also represents a lot of opportunities.

The pricing's been relatively consistent. We've been talking over the last few calls something in the order of magnitude of 1.5% to 2% on pricing, so I don't think you're going to see anything different there. And books, I don't think see we're going to see anything significantly different there. I think we clearly knew going into the second quarter 2011, that there was some non-sustainable profits improvements that were achieved in World Color in the second quarter of 2010, so from the point of view that we now going into the comparisons of in the third quarter, it was Quad third quarter 2010 as well as Quad third quarter 2011 instead of kind of putting these 2 Companies together in a pro forma.

Okay. Thanks for that. Just on the volumes, you noted that the plants you moved worked to had experienced a 30% increase in volume, but overall, what was volume like?

I think volume was, we're not trying to kind of break out a lot of the details on volume. I think you can sort of put together that the, sales were relatively flat, and pricing was down a little bit. There's also mix that's going into that.

Okay. And thanks for the disclosure on the, on books being about 7%. I recall it directories pretty small but it was around 4% of your Business, is that still true?

Yes.

Okay. And I guess the, the only other thing I just wanted to ask was Q2 is kind of a tough quarter because it's the least important quarter seasonality, were there any significant cost items during the quarter that you haven't broken out that might have skewed the numbers or is it pretty much all in there?

No I said Scott. We recognize that as analysts you have to break things out into quarters but we had different moving parts in our quarter but frankly we met plan. We were there where we expected to be from a revenue point of view and from an EBITDA point of view, so it's not, there was nothing different to us. We didn't internally view this as, as a miss. We viewed it as what was expected. I think we were trying to be open and candid that we saw a little bit better in volumes than we originally had in our forecast, so we think we could have done better, but there was, as a net basis, we're exactly on plan with the quarter and frankly the first half. It's, our revised guidance speaks more to some trends.

Okay. And just on those trends, on the Donnelly call they had kind of a tough quarter but they sort of indicated that things seemed to be getting better. That they had a good last month of the quarter but your approach is seemingly a bit more cautious. How is the book building for the second half of the year?

I think it's important to also understand, that 2 completely different businesses, they have a lot of other products that we don't, but I think what we did see and we said it in the script was that in, if you look at June and July, we did start to feel a little bit of an impact from the, from the economy that we're seeing, the lower GDP growth seems to be appearing. And so as we look at that and as we go forward, we are concerned about those trends when you think about what the economy's doing.

And Scott one of the things that's frankly hard to compare, especially 1 company to another, is when you try to look at months, we can kind of share anecdotally what we're seeing, but we also have shifting between months. So we can have work that we would have originally expected to be in July that ends up from a customer scheduling point of view shifting into August. You can have, you have work that shifts both ways back and forth. So I'm not sure you can try to draw a correlation based on comments on a couple of months. Other than to Joel's point, we saw some softening 2 months in a row and that caused us to take a little bit more conservative view of the future.

The last 1 I have is just on the frictional costs, $20 million to $25 million. Now you've closed 9 plants of the 10. I've got to think these frictional costs are kind of at a peak right now. Is that a reasonable assumption?

Yes, we're going into the busy season and again, on average, the plants that were on the receiving end of over 400 titles increased their volume by 30%, and that really means that we've literately hired hundreds of people and we've brought equipment up that was standing idle. There's a whole lot that goes into those frictional costs and a whole lot of effort that when you're taking on that volume of work, in terms of just training teams, getting teams used to working with each other, and don't under estimate the importance of getting some time under your belt on the new title that you have. Each title has very unique attributes to it, and, and you can't just turn a light switch and have it go from one place to the other and expect productivity to improve just based on the new title. Now add in the fact that we're bringing teams up to speed and hiring people and all that, really creates a lot.

Again, the first part of this integration has some very bold moves with over 10 plants, and that represents a huge amount of the work that we're doing from the standpoint of things moving from 1 plant to the other. Now frictional costs don't go away overnight, and people don't learn their jobs in 2 days after being hired. And so it's 1 of those things that we know what it is. We know how to manage it. It's what pace can we continue to bring productivity up to speed and reduce some of those other frictional costs.

Great. Thanks very much. I'll leave it there for others.

Dan Leben.

First, could you talk a little bit about the weakness you saw in June and July, were there any particular segments, magazines, catalog, retail, or books where that was more pronounced than the others?

No.

Yes. I would say it was just, it was a general softening. I mean, obviously the books thing we talked about. But when you talk about magazine, cat, it wasn't 1 more pronounced than the other.

Okay.

And it's not like it fell off the face of the earth. It's more that you're just seeing enough to kind of to take pause and understand what's going on with the underlying GDP in this country.

Okay. And then when you step back and take a look at the books business being 7% of revenue, does the profitability of this business given all the dynamics going on, with Borders going under, tablets and E-readers and so forth, why does this Business makes sense to keep investing in? Is it highly profitable? Help us understand the dynamics of what you find attractive about this segment.

Well, I think it does represent some additional diversification, frankly was the way we look at it. It's a segment that's going through some pretty dramatic change. It's the publisher model changing to the shorter runs. It's a lot of things that are going to emphasize our capabilities around operational excellence. And so we feel, we feel good about the segment. We're trying to understand all the differing changes to it, and as Joel indicated, like other segments that are mature, we're looking at this, from a revenue line, we're looking at it from a profitability line and also from a free cash flow point of view.

And I also think that, clearly there's a lost discussion about, the digital impact on books out there, and within books, there's obviously multiple segments and some are hurt more than others with things such as the Kindle, whether it's trade in mass versus educational, and when people forget there's also digital impact when it comes to digital print technologies that have evolved very quickly. And when you look at part of the supply chain in books with more inventory than I think people want, you start to employ that technology to reduce batch size, and to reduce the size of the runs, which is what the publishers want. We know how to do that, and it's a place that I think we can do well on.

Okay. And then John, I really like the Slide 16, I appreciate the detail on the bridge, just to clear up the $10 million to $15 million in other impacts, are those some of the 1-time things that were going on at World Color, is that how we should think about those other impacts?

That's just a whole composite of a lot of different things that none of them individually rise to, something that is going to really try to explain what's going on in the quarter. So I wouldn't reading anything into that.

Okay. And then last 1 from me. If you could just talk about the what contribution there was year-over-year from paper as well as foreign exchange?

The foreign exchange was a little bit less than, on the sales line Dan was a little bit less than 1%, had essentially no impact on the earnings line, and the paper, I believe, was, I'm just kind of trying to find that. I believe it was about 2% on the sales line, but because paper, that's all pass-through, that had, again, no impact on the bottom line, so those increases did not have an impact on Q2 EBITDA.

Great. Thanks, guys.

Drew McReynolds.

Just a couple follow-ups here. First again would reiterate, thanks for the additional disclosures. In terms of the timing of the remaining synergies, if you look out over the next 12 months, I guess just in broad strokes, is it more kind of a straight line realization at this point? Or, is that the wrong assumption to make?

Well, I think Drew, it's pretty hard to kind of plot out the exact timing of when you, when you're able to get a plant down, when's the next additional move that, that you can make. So I don't know that we can lay something out specifically. I think you can take a look and say that, and say that we, we're comfortable that it's 24 months. We're comfortable that it's more than the $225 million, and with the numbers that you've got for Q2, and for the first 12 months, we're okay.

And Drew, you think about the stuff that we've already done so far, those were sort of the big bold moves that were a little more clear cut in how you do it. Some of the next stuff that we're doing, are more complicated. It's not necessarily always, whether we're going to take a plant out. It's more along the lines of how do we make things more efficient? How do we move certain things around to make it happen. So it's not, it's not a simple answer. The next phase is more complicated than really the first phase, if that makes sense.

No, that's, that's great. Just back to the $10 million to $15 million in other impacts in the quarter I certainly appreciate John it's a whole bunch of different items. You flagged it as kind of 1 of the reasons for the reductions year-over-year. Are all these items somewhat kind of recurring from quarter-to-quarter, like how should we, we look at that?

Yes. I think we're always going to, in a Business this size, we're always going to have that level of noise. They look more pronounced in second quarter. The second quarter is always the low quarter, Drew.

Yes. Okay. That's, that's fine. When you look at the World Color comp going into the back half of 2011, so i.e., 2010 obviously you largely own World Color at that point, but is there anything unusual that we should be aware of, outside of all the other moving parts in terms of kind of, just a basic year-over-year comp?

No, I think the thing that did continue to exist in the second half of 2010 for World Color is the absence of retirement benefits. So those were not restored by Quad until January 1, 2011. They were also under the previous wage reductions that had taken place in some of the other benefits that had been eliminated, and as we shared in the first quarter call we put through an overall merit increase for everybody in January 1. So we'll continue to feel some, but not to the level that the first half and especially the second quarter was.

Okay. That's helpful. Thank you. And maybe over to you Joel on just visibility looking into the back half of 2011. Certainly, it is obviously a seasonally back half weighted business for you. I guess my question is, to what extent, are your plants kind of booked in terms of business because in a hot market, my understanding is you can turn away business particularly in Q4, are you pleasantly booked up let's say for that seasonality strong back half?

Well, yes, it definitely is the second half of the year that, that tends to be tighter, and I'm not going to break out or comment on specific segments. But certainly, the events of the day, this past week, the week before with what's going on in the market and sort of the uncertainty of what it means to the economy, it's something that we take note of, and really I can't tell you where it's going to go second half. What I can tell you is that what we've already seen in June/July is a slight softening. We're going to monitor it. As I said before, the slide in June/July wasn't like an off-the-cliff slide but it was enough just to be noticeable. So again we said, June/July you see this trend and you see the additional noise in sort of the world today and you take note. But generally speaking, the second half is fairly busy and we'll understand it as it happens.

I think, Drew, I think we're looking at normal seasonality as we go into the second half. Say, I think from a Management team's point of view, the things that are under our control is what we're doing with efficiency and productivity and trying to manage the frictional costs and that's going to be our focus. As you know, 1 of the challenges most businesses are having today is the visibility, and frankly, our customers don't have a lot of visibility and cataloguer's are going to react to what they see as demand and response rates and they move very quickly these days. And publishers will respond with what they see in advertising pages, and so we'll flex with that as we've said in the past. The World Color acquisition gives us more of a shock absorber and ability to deal with that. So that's something that will come to us and we'll focus on what we can control.

Okay. No, that's great. Just 2, 2 final questions here. In terms of the scope of the integration versus the original plan, when you look at meeting your synergy target, has the scope of the integration expanded since you started the integration or is it largely all falling into place versus what was originally going to be the blueprint?

Well, we continue to stick to the fact that we think it's $225 million in synergies and we're tracking well to that. But these things ebb and flow. You don't lock in a plan day one and say this is exactly how we're going to get there. And so different things evolve as you go through it. Especially if you get into the more complicated part because people are well into the business, they're seeing new things. They're seeing new opportunities or other things that you thought were opportunities, may not makes sense. And so it's kind of an ebbing and flowing of the process, but we feel very comfortable with the plan that we laid out. We feel very comfortable with what we're achieving. And so we'll continue, we obviously want more. If you look at how the team is come, the more the merrier, but we're not going to do things that don't makes sense for the long-term Business. But we will continue to look for opportunities, but right now, we're very comfortable with where we're at.

Drew, I think we identify that there were 4 key buckets of plant consolidation, SG&A, procurement and logistics and that those are going to be the main drivers and that's what we're continuing to find. So as Joel says, within each of those buckets you get some moves but across the buckets, it's the same as what we expected to see.

Okay. Thanks, and just final comment I guess for you Joel. When you look at the book business I appreciate there's, there's devil in the details underneath. You can't just paint the same brush over the book category, I guess, the push back you often hear from investors at this particular point is. When you look at print segments, flight directories or books, you're passing that inflection point to some extent where there's certainly an accelerated substitution to digital. I want to focus in on the magazine segment and you've been pretty clear on some of the positive trends in magazines as least over the last 3 to 4 quarters. To what degree or visibility or comfort do you have that inflection point in terms of magazine printing obviously in lieu of tablets out there is not right around the corner like it appears to be in the book segment.

Well, it's a good question because I think there's lots of news out there about the magazine world and what's happening with single-copy-sales and that's been challenged but I'll tell you that single-copy-sales in terms of news stand have been challenged for 20 years. Part of it is that the actual distribution structure of that part of the industry is really inefficient and really not done well. So I'd be careful about when you look at news stand sales but when you look at actual circulation of subscribers, it's held relatively well through the recession. And continues to. And I think that, from a broader commentary standpoint, what I think the magazine world is understanding and really taking advantage of, is that it's about their brand. It's not about their brand be consumed 1 way or the other. It's about subscribing to the brand and if that means I'm going to get it as a subscription or I'm going to go on-line for some late breaking things or do some searches, or on mobile,

I think that the opportunity for the publishing community is to really tie that together. Because when you do that, you're going to see some, you're actually already seeing some pretty positive stories about how you actually create some subscription sales through that. There's a couple articles that just came out in the last couple of days that actually speak to where people are doing well. So I think that the world will continue to change, but I continue to believe that the consumer likes to consume it all in whatever way they have available to them, and the opportunity for our customers is to figure out how those all play together. So we will continue to manage our platform also manage our technologies and develop technologies that help them make those linkages, because we see the connection to the other forms of media as an opportunity rather than a threat. Some things will change. But on the other hand how, how well you do that, I think, really speaks to, to where things will end.

Okay. Thank you very much.

Bigsby Stewart.

First, if you just step back a little bit. Could you give a little bit a qualitative assessment on sort of your thoughts around the overall World Color business? You've now sort of kind of known it, and owned it for a while. Just sort of surprises to the upside, surprises to the downside, where your expectations haven't been met, where they've been exceeded, any sort of major new business wins, losses, pricing, just an overall qualitative assessment how you feel about it?

Bigsby, I don't think that we've seen anything that has been surprising to us. I think that we've talked a fair amount on books on this call. That's between the Borders, which was a very disruptive event and some of the technology that's changing there, we spent time on that, but frankly some someone brought up directories. Directories frankly have played as well or better than what we thought, and frankly, again we learned a lot looking at that as how that business is run very successfully from a free cash flow point of view. And again I think as we indicated, in, in talking through this, we're going to look at businesses differently depending upon our matured geography or matured segment in which case we're going to emphasize free cash flow. I think that's a huge thing that's why we wanted to start breaking it out. Even in this first full year, even with all the frictional costs we're incurring, that we have a Business apart from the non-recurring that's generating $260 million to $300 million of free cash flow, and we know that's something that we're going to be able to grow into the future. So as we look, yes, you have some wins and losses in some of the different segments, but we don't see anything in the various segments that represents a surprise to us.

We would obviously like -- we would love to see pricing in the industry better, but we can't control that, and you look at what the economy's doing, we wish that was better, so I think some of the things that we're disappointed in our outside of our Business, but more on the general economy or industry as a whole.

Okay. Thanks. And just the, I'll reiterate that slide, Slide 16 is very helpful. Do you, do you have an estimate of what frictional costs were over the last 12 months?

No, we haven't, we haven't tried to break that out and stuff. Bigsby, we worked at this for this call because as we met with varying investors and analysts, this was something that people were really trying to understand, but we haven't tried to go back and break it out by quarter.

Okay. Well, you do understand my question it, same reason why people think it's helpful in the quarter, it would be helpful to get a sense for what it was over the last 12 months because you can't tell what your earnings potential are, is. It's very unclear what synergies you've realized but we don't know these items, but, so that's not helpful. And what about, what makes something frictional costs, what makes you not be able to classify that as a restructuring cost? I would think that if you were closing a facility and you need to train a bunch of people because people are coming over, that could fit into a plant consolidation, why doesn't that fit into sort of plant consolidation restructuring costs?

The restructuring cost is going to be something from an accounting point of view that's going to be very definable. So it's going to be like a severance cost, it's going to be a carrying cost on a plant, it's going to be, it's going to be those sorts of items It's not going to be -- in order to do this, Bigsby, the reality is, you have to make some estimates. The thing about a manufacturing operation as large as some of our plants are, and to think about transferring work, and you've got to remember we're a job shop and it's very complicated work. As Joel's pointed out, every job is different than another. To take that and increase everything by 30% when we talk about a net reduction of 3,400 people, the gross reduction is more like 5,000, so we've hired over 1,000 people in different places. That's just a tremendous amount of things. So in order to look at frictional costs, you're looking and you're making an estimate of what do I think things should have looked like if we were operating in a normal state? From an accounting point of view, there's no definitiveness to that, and you're never going to be allowed to re-classify that and consider that to be a non-recurring.

Okay. And just, this is a follow-up to something that somebody else had asked on paper sales and I think in the past you called it by-product revenue, could you just help me understand what by-product revenue is, and then what is the overall sort of magnitude of paper sales and by-product revenue?

We have not historically broke those out, Bigsby.

So is it -- would you say that it's material or immaterial?

Total sales are going to be material because paper ends up being a large item, and I think that might be in the -- I don't know if that's in the Q but if not, we can separately get you what the paper sales are.

Okay.

But again, the key thing as far as impact on the quarter it had an impact on the revenue line. Didn't have an impact on the EBITDA line because of the pass-through nature, and therefore actually had a negative impact on the margin for the quarter.

Okay. Thanks very much.

Ron Gutfleish.

You talked about being comfortable in leverage, 2, 2.5 times, you're there right now. What can you do with your free cash? So how, assuming, you're generating free cash at a huge rate. Your free cash yield in relation to stock prices it's approaching 30%. Are you able to buyback stock? And would you consider it?

Well, I think that we looked. We look at there's going to be 3 primary uses of free cash flow. The first is going to be to de-leverage and de-risk the balance sheet, and that's where we said we started when we closed the transactions. That was really important and when you look at the, the combination of the pension liabilities and the debt, it's just a little bit less than $400 million of de-risking that's been accomplished.

Second thing is to invest into the Business. Which we've continued to do and the third is to provide a return to shareholders. We had originally indicated that we would address a dividend policy in the second half of 2011, that goes back to when we closed the transaction because we felt good about where both the integration and free cash flow was. We accelerated that decision that we announced in May, and as we said, we thought that the appropriate way to begin a return to shareholders was the dividend policy. And we haven't, we have no change in our philosophy or strategy towards the use of free cash flow. It will continue to be those 3 things. So nothing's changed on that.

So if, as you generate free cash, you'd expect to give it back through dividend? I mean, some you already de-risk -- as you de-risk the balance sheet, understand investments, and maybe you can find attractive things at this point I'm not arguing with that. But the third method would be through dividend.

Correct. Correct. I think we're going to balance, this is something that we're going to be reviewing internally as we discuss this with our Board on a every kind of 3 to 6-month basis, so if something changes because frankly we can't find the opportunities, and to your point, if we've de-risked the balance sheet and we're down to 2.0 then we can re-evaluate should we be increasing the return to shareholders. On the other hand, hopefully as a Management team, we're going to be able to find opportunities for investment that are going to create value. But we're going to try to have a good solid 3-legged stool of these 3 items.

I understand that, and when you set that up, though, you said it in sort of certain return profile, since that time your stock has fallen more than 50%. Which might indicate a re-look at that. It's hard to find stocks that have a free cash flow yield higher than yours but the ones that do are taking advantage of that, which actually means then the market's going to sell your stock at $20, you take advantage of that and we get paid more later on.

Well, I think the way we set our dividend, Ron, was we set it based upon looking at our level of earnings and free cash flow and what was appropriate to that as opposed to looking at it from a dividend yield point of view. We're obviously comfortable at the dividend level, and as things change, whether they're good, whether they're opportunities regarding the stock or whether there's opportunities regarding growth, we'll evaluate all of them. But I can tell you that nothing is different at this point in time.

Martin Braun.

Question on the Transcontinental transaction, when do you expect it might close?

Well, we have 2 parts of the transaction. We have Mexico and we have Canada, and it really depends on the anti-trust process that we can't predict at this point. We do expect that both will close sometime in the second half, and as we find out more, we can let people know.

And from an accounting point of view, at what point do the Canadian operations that are being sold come out of your accounting financial results?

That will be in the third quarter.

Yes. I'm assuming that whatever EBITDA is contributed by the assets that are being sold is part of the guidance for full-year EBITDA?

That is correct.

All right. I noticed that the capital spending plans for this year are somewhere upwards of $200 million in the previous presentation I believe I saw breakdown of some of those items. And I wanted to ask whether this level of CapEx was typical for the Company or was unusually high or otherwise?

Well, I think we've been talking since we've closed the transaction that as we looked at 2010 and 2011, that we thought the correct level of capital expenditures was $170 million to $200 million, we were just a little under $100 million in the first 6 months, we traditionally tried to front-end load CapEx, so we frankly have the value of that equipment either from a revenue or cost savings point of view in the second half of the year. And each year as we go through our annual planning strategy process, we take a look at what we expect going forward, and make decisions including what we think is the right level of capital expenditures, we have not determined the policy for 2012, so I think that's something that we would be talking about in kind of Q3 and Q4 when we provide that guidance.

What was the level of capital expenditure in 2010?

I believe it was $150 million or $160 million, I'm kind of working off of memory, so if I, I believe that was the amount.

Right.

And frankly you have some timing things so you can think you're going to end up with something that starts up late in the year and it starts up early in the following year. So you get some things, what we reported was $113 million, but that was only 6 months of World Color, so I think you put the World Color in, that's where I think it comes to approximately $150 million.

All right. Thanks. Another question on the ESOP it's been around I guess quite a long time and is a large shareholder of the Company.

Correct.

Obviously ESOP was established when the Company was private. The Company is now public, the transition from going from a public to a, from a private to a public company and now having a publicly quoted stock price, how does that affect the ESOP?

It really doesn't. I mean, other than it sees the volatility of what happens day-to-day, whereas in the past there was an annual valuation, but we were always required under [ARISEP] a to have a market based annual appraisal. So it was valued once a year. So the only real difference impacting that is the fact that it's, it essentially gets valued every second as opposed to once a year. But other than that there was no operational changes that were required as a result of going from private to public.

I see. I was wondering if it was somewhat disconcerting to long-time employees to see their stock lose over half its value whereas in the past they didn't have to deal with that sort of thing?

It was disconcerting to see $2.5 trillion of value get lost in the last 2 weeks in the broader markets too. We've always been focused on the long-term of the value we can create in this Company and we will continue to.

All right. That's it. Thank you for your time.

Jeff Armstrong.

2 things. 1, when you guys talk about kind of the 3-prong approach of kind of what you're going to do with free cash flow and you talk about investing in the Business, is that in excess of the CapEx that you talk about?

Yes. Yes. So it's going, we're always going to take a look at our opportunities and I think we're going to put them into effectively e buckets. 1 bucket's going to be the organic growth that we can achieve, so that's going to be focused on growth. The second's going to be CapEx that we can use that can take substantial amount of cost out. And the third's going to be the external or acquisition opportunities whether it's in a growth market or whether it's the consolidation opportunity. So we're going to look at it across all 3 and look at the deployment of capital accordingly.

Okay. And so it's really the third one kind of acquisition bucket and then I guess hopefully that, the priority of that would shift based on kind of where you get the better return on capital. And kind to echo someone else's point, the stock price went down 50% maybe buying back stock is a better return on capital there. And again, is with I guess the second question I have, with respect to the frictional costs, page 16 was very helpful to kind of break out what those are. Is it a fair assumption to assume that it's been kind of running at $20 million to $25 million since the acquisition took place?

No. Because I think that you've got to remember that in Q3 of 2010, we really hadn't done a lot of integration at that point in time. We really started the impact of the plant shutdown really started in the fourth quarter, so you're going to have seen that, in fourth quarter of '10 through second quarter of '11.

Okay. That's helpful. And then final thing. Kind of the other 3 components of the EBITDA decline there, are also helpful. Is it fair to kind of apply those back the last 3 quarters as well?

I think we saw the, I would say no, as it relates to books. I think that, yes, we started seeing that impact of Borders in the book market in the first quarter of 2011 but clearly that event had not happened in Q4. And I think the answer to others would be yes.

Okay. And then last thing, and I may have missed this earlier but the $10 million to $15 million of other impact, you said it was a bunch of other things, but you guys have talked about kind of the 1-time snap-back in, in World Color employee costs, is that in that $10 million to $15 million bucket?

Yes.

Okay. All right. Thank you.

[Sam Saleme].

Just a question on, when you guys talked about how the $126 million in EBITDA was, that met your plan, does that mean that you guys are lowering guidance basically on the second half?

Yes.

And is that just due to pricing or what are pricing trends do you think in the second half compared to last year's second half?

Well, I think there's really 3 things that are driving us to be prudent in adjusting and widening the guidance. The first is the continuing level of frictional costs that we're incurring, and the time that it's going it take, especially when we're, the plants are getting busier that doesn't make it necessarily easier. The time that it's going to take that to get fixed. Again we remain comfortable that's under our control and that's temporary. Secondly it represents the, what we see happening in books, and we expect that to continue. And the third is, frankly the softening that we saw in the economy and the GDP revisions down, the reduced level of consumer spending, the continuing high unemployment, those are 3 major drivers of where we see print demand as we look ahead. So seeing what was happening in those major macroeconomic drivers, and seeing the impact on June and July, those 3 things together are the things that told us.

Now recognize that we're a seasonal Business, and we make a majority of our earnings in the second half of the year, so we're doing it at this point because frankly, we're, we'd rather be on the conservative side. We'd rather share kind of where we see some concerns, and how they might impact the Business, so even though we were on plan, we like to build those things in and try to be as transparent as we can about them. But clearly there's just a lot that gets told in all printing companies when you see second half results.

And 1 last 1, just on Slide 20 for the forecast in Canadian, you guys are showing that EBITDA is coming down significantly, so do you guys not see that happening in US for 2012?

I think that in Canada as Joel indicated, it's a competitive market, but unfortunately we had some significant customer losses that were taking place. There's some changing dynamics that are taking place in Canada, as it relates to, as American retailers come in, and we see some pretty significant price decreases that were taking place during those renewals and frankly we were in a less competitive situation because of the absence of investment into the legacy World Color platform as compared to our competitors, especially Transcontinental.

Okay. All right. That sounds good. Thanks.

Thank you. So as we conclude today, I'd like to leave you all with several thoughts. We have reached the halfway point in a very complex integration and we're pleased with our progress and success to date having achieved $120 million in synergies. In 1 year we've de-leveraged our balance sheet by paying $233 million in debt, and reduced our pension liability by $145 million since close. That de-leveraging helped pave the path to our very successful debt refinancing, which provides us the liquidity and flexibility to invest in the Business for long-term profitable growth. We announced the Transcontinental transaction that's creating immediate value at close through the reduction in pension obligation, as well as incremental positive adjusted EBITDA in the near future. And despite the headwinds we face, we are taking about a Business that generates a tremendous amount of free cash flow, and we estimate we will generate between $260 million $300 million in recurring free cash flow this year. Each of these are significant achievements and I'm very pleased with what we've been able to accomplish. Our future at Quad/Graphics is indeed very bright and I thank you all for joining us today.

This concludes today's conference call, you may now disconnect.