Quad/Graphics Inc (QUAD) 2011 Q3 法說會逐字稿

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Quad/Graphics third quarter 2011 conference call. During today's call, all parties will be in listen-only mode. Following the speakers' 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 Treasurer 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 by reviewing the financial and operational results for the quarter. John will follow with a more detailed review of third-quarter results, an update on our share repurchase program authorized in September, our initial thoughts on 2012, and updates on our cash flow guidance and puts for 2011, as well as our initial ranges for 2012. John and Joel will then take your questions after their remarks.

While our as reported results for the quarter are now comparative, having passed the 1-year milestone for the Worldcolor acquisition, we will continue to make comparisons to the pro forma Company for the full year to date 2010. This quarter, on our SEC financial statements, we have begun breaking out Canada as discontinued operations following the announcement of our swap transaction with Transcontinental of their Mexican assets for our Canadian assets. However, our comparisons in this morning's review of the operating and financial results will not yet exclude Canada, so that it's easy to compare periods. We will make clear when we're referring to results excluding Canada. 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 as 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 third-quarter earnings press release issued last evening. A replay of the call will also be posted on the investor relations section of our website after the live call continues. I will now turn the call over to Joel.

Thanks, Barb, and good morning, everyone. During the third quarter, Quad/Graphics celebrated our 40-year anniversary in the printing industry. Without question, the printing industry has undergone countless changes during our first 40 years, and it will continue to change. I am proud to say that we are a driving force behind the change to make print more immediate, personalized and relevant, and are strengthening how it compliments and connects with fast-evolving technology such as smartphones, tablets and other emerging mobile technologies. Daily, we are helping marketers and publishers unleash the power of print. Thanks to our technologically advanced platform, we can help our customers maximize creativity and ROI, while generating significant time and cost savings. We are printers and innovators and are energized by prints ability to drive business results for our customers.

While we remain confident in both our strategy to redefine print and how we execute that strategy, the uncertain economy and its impacts on our volume, including declines in books, intense industry pricing pressures and a temporary decline of productivity have impacted our third-quarter results. We are operationally impatient to improve these results and on today's call, we will discuss our focus on progressing on our integration plan, maintaining our strong balance sheet, staying strategically disciplined to manage our cost structure and position the Company for the future, and increasing and maximizing value for our employees, customers and shareholders. In other words we are doing everything in our control to keep our Company strong and moving forward. I am confident in our ability to manage short-term challenges, and believe we are well positioned for long-term success.

For the third quarter, net sales were $1.19 billion compared to $1.21 billion in 2010. Volumes were lower than expected, primarily due to the challenging and uncertain economy, as well as the impact from books and Canada. Continued aggressive pricing in the print market also affected top line results. We saw a positive impacts from paper and by-product revenues, and as well as foreign currency translation and logistics revenues. Adjusted EBITDA at $173.6 million and adjusted EBITDA margin of 14.6% were higher than the 2010 third quarter results of $159.2 million and 13.2%. Excluding our Canadian operations, our adjusted EBITDA margin in the third quarter 2011 increased to 15.6% versus 13.6% a year ago.

Incremental Worldcolor transaction synergies of $32 million and lower incentive compensation expense, increased adjusted EBITDA in the third quarter. Partially offsetting those increases were volume declines, primarily driven by economic uncertainty, and included continued reductions in the book market and lingering frictional cost which are mainly productivity declines due to transitioning work from plants being consolidated, as well as aggressive industry pricing. We continue to believe the productivity decline is temporary, and directly related to the unprecedented level of complexity in this integration, and we are confident that we will return to more normal levels of productivity as we progress through the integration.

Since the 2008 and 2009 recession, our industry with Quad/Graphics included has had significant excess capacity. The key benefit of the Worldcolor acquisition and where we will achieve the largest portion of the synergy savings is in creating a more efficient platform. By combining the 2 Companies' footprints and volume, we will better utilize the most efficient capacity, and shutter that capacity that is not needed. We are improving our utilization significantly and continue to see volume increases in our remaining magazine and catalog plants of approximately 25%. We are making long-term sustainable improvements in our cost structure, and continue to believe this was a very strategic acquisition that will create value for our shareholders long term.

With this large integration have come restructuring costs as well as those costs we have called frictional costs. As we have mentioned, the main driver of these costs is the temporary decline in operational productivity that occurs in the plants that have received the most significant increases in volume. This decline is caused by factors such as the large increase in the number of new employees who are learning their jobs, people being promoted to new roles, and newly formed crews on our equipment that are learning to work together. It takes some time for the new employees and new teams to become efficient.

But the plant's efficiency will improve, another example of the implementation of our smart tools ERP tool set, at newly acquired Quad/Graphics plants. In the long run, these tools improve productivity. But it takes some time for the tools to become effective. The outcome in our plants of these and other ramp-up activities has been production equipment running below target speeds, increased set-up or make-ready time, increased downtime in our operations and other impacts as we shifted the 400-plus titles to new plants. We knew from the start that this integration was an intricate process which is exactly why we established the 24-month time line. We saw some selective productivity improvement in August and September, but as we continue to integrate the platform, we expect to see productivity ebb and flow and we know that the improvements won't happen in a linear pattern. The all-out efforts being made by our team have been outstanding. We are by no means satisfied with where we are today, and with the progress we have seen, we are confident that we will return to more normal levels of productivity, once the consolidation activities are complete.

As I discussed earlier, we continue to experience headwinds in the market in both the languishing economy and therefore our industry. We believe Quad's technologically advanced and automated platform allows us to be a low cost producer which will better position us to endure the challenges we face. Economic uncertainty had an impact on volumes this quarter, resulting in declines across our end market, and we expect that going forward, that our economy will remain weak. We have and will continue to respond by adjusting our cost structure as necessary, both now and in the future.

Pricing continues to be intense, and we are taking a strategic and disciplined approach to how we compete. As we make pricing decisions, we always look to strike the right balance between pricing and volume. The decision to walk away from business opportunities is difficult. But we believe that pursuing prudent profitable volume is the right way to create shareholder value. This disciplined approach has proved effective as we continue to win new business.

For example, we just entered into a multi-year agreement to expand our service footprint and provide complete end-to-end services for a fast-growing multi-title cataloger. The agreement which will exceed $135 million over the life of the contract covers 100% of all catalog printing, pre-media, creative page layout and production and paper purchasing services. It will include our proprietary catalog studio content management and work flow solution as well as 100% of production of product photography and video content creation services. We are particularly excited about the video services we will be providing, as this is a fast-growing part of the online and mobile catalog environment and the perfect compliment to our digital photography services we are providing.

Our multi-channel solution offering which includes print and web-based solutions is helping customers like Stag-Parkway achieve their marketing and sales goals. Stag-Parkway, the largest after market supplier of recreational vehicle parts and accessories to independent dealers in America was looking to broaden its support of its dealer network. By offering a targeted and user defined marketing program, we introduced Stag-Parkway to [q Connect], our automated web-based solution for creating multi-channel marketing campaigns. Through q Connect, dealers will be able to manage their catalog campaigns and execute print on-demand targeted programs where they will select a design template, personalized content, select recipients, choose a delivery date, digitally print the jobs at Quad/Graphics and we will deliver them through the USPS.

In the book market, we are continuing to advance our solutions to help publishers reduce inventory and obsolescence and preserve capital. In our press release today, we announced a new agreement with Penguin Group USA for short run and print on demand production of it's US trade hard cover, trade paper back and mass market books. Our growing digital printing platform, which we have expanded capacity by more than 500% in the last year, was a key factor in securing this agreement because it supports the virtual inventory model of select titles that will help Penguin print in small quantities efficiently and on demand.

Our economy is uncertain and we have limited visibility on its impacts on our markets in the future. As a result, a top priority is to ensure the business is both lean and flexible so that we can adapt as the business conditions change. This means serving our customers seamlessly, maintaining a strong conservative balance sheet, improving productivity, taking out more costs to better align the business to our reality today and into the future and evaluating the best uses of our capital to create value for shareholders. After a close review of the quarter's results and the uncertain economic conditions we face, we believe that revising our adjusted EBITDA guidance downward for the remainder of 2011 is appropriate. We see 4 factors impacting EBITDA and I would like to outline how each one has performed since last updated guidance.

Industry volume, which was lower than we had forecasted due to macro economic pressures, had the greatest impact on our full-year projections. Pricing continues to be a challenge both for Quad and our industry and expected to be going forward. Although we do see measurable progress, productivity continued to impact us negatively and the incremental costs we incurred in the quarter were beyond what we estimated at our last update. Some recent productivity improvements give us confidence that we will operate at a more normalized level of productivity and put the associated costs behind us, once the Worldcolor integration is complete. The final impact is synergies. I will provide a full update shortly, but we continue to be on track achieving our targeted synergies.

Based on these factors, we are revising our adjusted EBITDA guidance for 2011 to $610 million to $625 million. However, we continue to believe our 2011 recurring free cash flow will be in the range of $260 million to $300 million as a result of our ability to manage working capital and discretionary capital expenditures. Our ongoing priority when we evaluate how best to deploy our capital is to create value for our shareholders. Priorities will change as circumstances dictate. For example, we implemented a share repurchase program in the third quarter. Dividends will also remain a priority for capital usage, and we remain committed to our dividend. Last evening, we announced our next quarterly dividend which will be paid in December.

We will continue to invest strategically in the existing business to keep our technological edge and drive efficiency. As we look to align our operational structure with current business levels, technology and automation will remain important but we'll be very careful with the use of capital. Finally, as we determine best uses of capital, we may look selectively at modest strategic investments in geographies and end markets with growth potential as we are doing with Mexico.

Our balance sheet remains strong, and this requires constant vigilance particularly in these challenging times. As we maintain our strong fortress-like balance sheet, continued derisking through debt reduction as well as pension funding and reduction will be key priorities. We believe both debt and pension reduction will create value and will also provide us flexibility and a margin of comfort if our economy remains challenged. We continue to believe that our leverage range of 2 to 2.5 is appropriate for our business.

We are looking at opportunities to create value for our customers, and in the process create value for our shareholders. For both marketers and publishers, print is the foundation of many successful multi-channel campaigns. Our recently announced interactive print solutions help our clients take print to the next level of successful integration with new media such as augmented reality and near field communication technology. By using the immediacy and interactivity of mobile to build on the proven power of print, we are able to help our clients drive more engagement and response. Our goal is to help our clients improve the return on their overall marketing dollar spend by offering the entire continuum of our solutions.

Additionally, in the third quarter, we expanded the benefits we offer our clients with the launch of our enhanced co-mail platform, which increases the postal savings benefit we can offer our clients through co-mail. The acquisition of Worldcolor has allowed us to increase co-mail, magazine, catalog and direct mail volumes substantially, and we estimate that in 2011, total volume will be approximately 4.9 billion pieces co-mailed. This compares to approximately 3.8 billion in only 2010, nearly a 30% increase. However, volume is only 1 component that creates value for our customers. As we combine that volume with our unique software to merge mail streams, on a scale of this size and leverage our mailing platform, we can provide even greater co-mail cost and efficiency benefits to our customers. With distribution being our client's largest cost category, we are able to provide them opportunities for very meaningful postal cost savings.

We continue to focus on the Worldcolor integration and remain on track. Last month, we announced 2 additional plant closures, which brings the total of facilities being closed to 12 facilities and represents over 5.1 million square feet of total capacity closed. Through the end of the quarter, we have seen a net reduction of approximately 3400 full-time equivalent employees, which excludes the employees who have recently joined us from Transcontinental, Mexico. And 1 of the tougher parts of the continued integration progress is parting ways with many good long-term employees, and we truly thank them for their service to Quad/Graphics.

In the quarter, we achieved $32 million of incremental synergies and $167 million since we began the integration. We remain on track to achieve both $225 million targeted synergies, and the approximate 1 to 1 relationship between synergies and costs to achieve those synergies. We continue to manage those items in our control. Adjusting our cost structure to current business levels, leveraging our operational excellence to be good stewards of shareholder's capital and maintaining a strong balance sheet. While we were disappointed with the results this quarter, I am confident our ability to continue to adapt and make the changes necessary to compete successfully. I will now turn the call over to John to present the financial review.

Thanks, Joel, and welcome, everyone. As Barb mentioned, because we have begun to break out Canada as discontinued operations in our SEC financial statements, I may make reference to those statements and the results excluding Canada. However, the basis for most of my presentation will be on the combined business to provide comparability from prior quarters.

Slide 17 is a snapshot of the third-quarter financial results compared to the third quarter 2010 results. As Joel mentioned, net sales were slightly lower than last year's third quarter at $1.19 billion. Cost of sales was $906.7 million, was 30-- 3.4% lower than third quarter 2010. SG&A expense of $105.9 million was down 5.9% from $112.6 million in 2010. Depreciation and amortization was $85.4 million and interest expense was $25.5 million. Recurring free cash flow, which we define as cash flow from operation, operating activities, less CapEx and excluding nonrecurring items, such as restructuring costs, was $146.8 million through September 30. Third quarter is when we see our seasonal peak in working capital usage, and that can be seen in this quarter's results. We believe free cash flow is an important metric for us, as we expect our business to continue to generate significant free cash. We are actively managing our free cash flow with particular attention to working capital and efficient investment in capital expenditures. The reconciliation of recurring free cash flow for the 9 months ended September 30, 2011, is included in the supplemental information located in our slide presentation.

We have again included an adjusted EBITDA bridge in our slide deck, to help better explain the impacts to adjusted EBITDA in the quarter. This quarter, the positive impacts include incremental synergies of $32 million. Total synergies achieved in the quarter were $47 million, and are shown net of the $15 million achieved in 2010. We also had a net benefit of $25 million from the reduction in our incentive compensation expense and $1.4 million of other net impacts. Offsetting these impacts were volume and price declines, which adjust -- which impacted adjusted EBITDA by $18 million. A weak economic climate was the largest driver of the decline. Integration-related temporary productivity impacts of $12 million for the quarter, $8 million due to the decline in the book business and $6 million resulting from our Canadian business.

Slide 20 shows the breakout of the $48.3 million in restructuring, impairment and transactional related charges for the quarter. Integration costs were $20 million. Impairment charges primarily resulting from the sale of our Canadian operations was $17.9 million. Employee termination costs were $4.8 million. Other restructuring costs, which include costs to maintain and exit idle facilities, as well as lease exit charges totaled $4.1 million. And transaction-related charges were $1.5 million.

Slide 21 shows our financial results for the quarter, with the Canadian operations removed. As we discussed in the second quarter call, the Canadian operations are running at an EBITDA margin significantly less than the total Company. And this statement shows a positive impact of removing those operations on our profitability, with an adjusted EBITDA margin from continuing operations of 15.6%. As reported loss in the third quarter of 2011, was $22.4 million, or $0.48 per diluted share, as compared to an as reported net loss of $232.5 million, or $5.01 per diluted share in 2010.

In conjunction with our successful refinancing in July, we wrote off $34 million of transaction costs in the third quarter related to the debt offerings closed in 2010 and 2011, which is shown as a loss on extinguishment of debt. Excluding the effects of restructuring, impairment and transaction-related charges in both years, and the loss on the extinguishment of debt in 2011, net income was $37.8 million, or $0.80 per diluted share in the third quarter of 2011, as compared to net income of $24.9 million, or $0.54 per diluted share in 2010.

Slide 23 is our summarized balance sheet as of September 30. As Joel mentioned, we remain focused on maintaining a strong fortress-like balance sheet through debt reductions, as well as reducing our outstanding pension obligations. We view this as especially important given the uncertainty of both the macro economy and the challenges in our industry.

Slide 24 shows the snapshot of our cash, debt and credit metrics as of September 30, 2011. Because we are at the seasonal point of the year when we use working capital, our efforts to reduce debt outstanding are somewhat masked. During the quarter, we also funded a $50 million deposit to Transcontinental at the close of the Mexican portion of the transaction. Pending Canadian regulatory approval, a portion or all of that deposit may be refunded to us. Our interest coverage for the quarter was 5.7 times. We normally see a seasonal peak in working capital in the third quarter with a corresponding increase in our leverage ratio. In spite of being at our seasonal peak, our leverage ratio at the end of the quarter was 2.46. Which reflects our efforts to both manage the components of working capital, as well as insure we invest in the right capital expenditures. We are pleased to be within our targeted range and continue to believe that operating in the 2.0 to 2.5 times leverage range is an appropriate target. At times, we may go above or below that temporarily, given the economy, working capital seasonality, timing of investments and growth opportunities.

As we discussed, we continually evaluate our capital deployment, with an eye toward shareholder value creation. On September 6, we announced $100 million share repurchase program. Throughout the month of September, we purchased approximately 391,000 shares and spent approximately $7.4 million. Because we were at our quarter end and entering a blackout period, our October purchases were minimal at just over 51,000 shares and approximately $837,000. Going forward, we will continue to balance the opportunity to buy shares with the maintenance of our strong fortress-like balance sheet.

We are very pleased with the $1.5 billion debt financing we concluded in July at favorable terms. The key benefits of the refinancing include extended maturity schedules at 5 to 7 years, an improvement in the underlying terms which provide us additional flexibility and annual cash interest savings of $16 million to $20 million. At the end of the quarter, borrowings under our $850 million revolver were $223 million, at an interest rate of 2.5%. The increase in the balance was primarily attributed to the deposit for the Mexico close, as well as a shift of borrowings from the old term loan B to the new revolver. Our floating rate debt today is at an average rate of 3.0%. Long-term fixed rate debt, consisting of private placement notes, continues to be at an average interest rate of 7.5%, and have an average maturity of 11 years, with a weighted average life of 6.5 years. The blended interest rate on our total debt is 4.8%, and the outstanding principal balances are 59% floating and 41% fixed. Given the increased flexibility under our new revolver, we believe we have sufficient liquidity for both current business needs and future investments.

Earlier, Joel discussed our updated view on both adjusted EBITDA and free cash flow for 2011. In that update, our intent was to walk through all of the EBITDA impacts we look at when forecasting our future results. Of the 4 impacts we addressed, which were volume, price, productivity and synergies, 2 of the 4, volume and price, are externally driven and continue to cause uncertainty in our future results. Our focus now and going forward continues to be on the factors which are in our control, getting back to normalized levels of productivity, achieving integration synergies as well as careful deployment of capital, maintaining our fortress-like balance sheet and adjusting our cost structure to be in line with current and future business levels are our priorities.

While we are still in the process of developing our 2012 plan, we believe both economic and industry uncertainty and volatility will continue for the foreseeable future and will continue to impact our results. Our very early look at 2012 indicates that our adjusted EBITDA may be flat or lower than 2011, due to a projected slow economy and continued competitive industry pressures due to excess capacity. Offsetting these pressures are the synergies we are achieving. Despite the challenging economic environment, we believe that 2012 recurring free cash flow will be of similar levels to 2011. Our focus will continue to be to work hard to impact the items in our control, such as cost takeout and free cash flow.

We have updated our outlook for the various items impacting cash flow for 2011 and have also provided our initial thoughts on 2012. For 2011, we expect depreciation and amortization to be $350 million to $355 million, interest expense to be $105 million to $110 million and capital expenditures to be $165 million to $175 million. We continue to expect cash taxes to be less than $10 million, pension cash contributions to be approximately $61 million and non cash pension expense to be approximately $8 million.

For 2012, we expect depreciation and amortization to be $340 million to $360 million, interest expense to be $85 million to $95 million, capital expenditures to be $125 million to $150 million and cash taxes to be less than $10 million. Our cash contributions to our pensions will be higher at approximately $125 million to $145 million, due to the cost of the withdrawal from the [US MEPS] which we announced earlier this year that we had reached an agreement with our global unions to exit. The timing and actual exit cost is still being determined but expect it to be in 2012. I would now like to turn the call back to Joel who will provide some concluding remarks after which time we will take your questions.

Thanks, John. Quad's 40-year history has been built on being successful in both robust as well as challenging times which is why I am confident we will be successful throughout this period as well. We will continue to control those items we can, be disciplined in our use of capital, and adapt our business to the changing needs of our clients and industry. This quarter, we saw the impact of the strategic asset swap transaction with Transcontinental, and we will continue to look for opportunities to improve our adjusted EBITDA margin. We expect to continue generating significant free cash flow and are doing what we can to generate returns for our shareholders while also working to secure our ability to grow and deliver value in the future. That concludes our prepared remarks. Operator, we are ready to take some questions.

(Operator Instructions) Drew Mcreynolds with RBC.

Good morning, Drew.

Good morning. Thanks very much. Just want to start this morning with I guess the -- kind of the implied outlook for Q4. A little, certainly a little surprised from my end just given Q4 is typically 1 of the seasonally strongest quarters, and we're all kind of doing the math on the incremental savings year over year, et cetera. Can you just talk, Joel and John, to kind of the sequential, it looks like to be significant sequential deterioration from Q3 to Q4 because from my end Q3 was largely in line but Q4 just missing the mark?

Well, Drew, this is John. Q3 remember that we referenced that we had reduced incentive comp in conjunction with the lower financial results that we were having. That was an impact of about $10 million. When you pull that out, and you try -- and you divide up the, I'll call it the impact of our revised outlook between what actually you've hit us in our third quarter based upon what we -- where we expect it to be when we shared the previous guidance, about 40% of it is in the third quarter and about 60% of it is in the fourth quarter. And when you look at the drivers of it, the drivers sort of in order of magnitude is the volume price combination, which is what's happening in the macro economy as well as the competitive situation in the industry. It's what is happening in the book segment, and then it's the lingering impact of productivity and the inefficiency as we load up the new plants.

I think from a context point of view, Drew, when I look back, probably the best reported number that we get that doesn't have estimates in it is what was actual magazine advertising pages. And when you look back to fourth quarter of 2010, finished the year with pretty strong results, with ad pages up 3.7%. Q1 was also relatively strong with advertising pages up 2.8%. Consistent with what we shared on the second quarter call when we started seeing softness compared to our volumes in the kind of June, July period, that 2.86% dropped to 0.6%, and what actually happened in the third quarter was a negative 5.6%. So hopefully that kind of provides some color as well as where is the difference from what we were expecting as we revised the guidance distributed between the 2 quarters.

And when I look at just attacking the pricing environment, I mean certainly pricing hasn't been great for well over a decade, it does seem that certainly we're kind of reaccelerating to the down side. Maybe Joel or John, you can kind of clarify, when we visited certainly your operations, your co-mailing abilities are pretty much state of the art, just wondering is there any levers like that, that you can pull more aggressively to firm up pricing for you guys in the marketplace? Or is this just kind of a hopeless battle from here on in?

Well, I'd say you saw 1 of our stated air plants which is these large mega plants and if you'll recall, 1 of the main reasons for the deal is if you go back to 2009, we had just come out of a recession and we took a look at capacity levels, and certainly the industry had a lot of open capacity as did Quad, and Quad had some plants that were the most state of the art in the industry. And so we took a bold move to acquire a much larger company than ours and combine those 2. And again, the premise here, and the big bang of all of it is to take that volume out of the less efficient plants and load up those more efficient plants. And so part of -- when you look at where we talk about productivity challenges, with these frictional costs, is that we've done this on a massive scale. I mean we're talking 9 plants already closed to date and we're only 15 months into it, 2 more announced. We've hired over 1900 employees, and so this whole ramping up thing is really important to understand, because these state of the art plants on average have ramped up by 25% in volume.

And so as we bring that all together, certainly the levers are is to be the lower cost producer, to be able to make sure that you can be nimble and be disciplined with what you're going to do on pricing, make tough calls when you have to make them where you're not necessarily filling up your expenses capacity with stuff that's going to create shareholder value. But also to enhance savings for our customers, just as we've announced the enhancement to our co-mail operation. That was just not a combination of grabbing the Worldcolor volume, that was taking the Worldcolor volume and enhancing the co-mail operations across the whole network to increase the amount of co-mailing we can do by up to 30%, as I said before. And so that's a huge gain. And so I think as you kind of look at it on a macro view and how we work with our customers, I mean distribution certainly is still their largest cost, and I think you really have to look at the whole bundled package of what you're offering them and combine them together to offer the best value with a low overall cost, and I think we're in very good shape to do that.

But that doesn't change the fact that there is still excess capacity in the industry. And so as long as that happens, you can expect to see people fighting out for that volume that they can get to keep the presses running. And I think what is important for us, when we think about the long term, is we will protect our flanks, we will fight the fight where we have to, and we will also be aggressive where we have to, where we see an opportunity. But we will be disciplined in that. And so it's kind of a long-winded way to answer your question, but I think it's important to have all of that into context.

Okay, no that's great, Joel. Just maybe a follow up and then I'll leave it for others. Kind of 2 part question here, when you look at your preliminary adjusted EBITDA guidance for 2012, I appreciate that type of guidance, where we're obviously kind of in and around the low 600s looking forward. The big picture here is people are going to try and figure out what then you add on for the elimination of frictional costs. Can you get to 700, can you get to 750? We do know what frictional costs were for Q3, Q2 and I appreciate these things are lumpy. But I guess the real question here is, do you see anything in the industry that would prevent you from achieving an EBITDA margin, not necessarily north of 20%, but up to the 17%, 18% level that you're accustomed to? Because I think that does speak to the things you can control, and I think people can better than square off looking out into 2012 and 2013, making their own revenue assumption, what kind of real run rate EBITDA you guys can generate.

Drew, this is John. When you look at the third quarter, on a continuing ops basis, the way we're now reporting from an SEC point of view, our EBITDA margin was 15.6%. So frankly, despite the fact that we have frictional costs and that obviously we felt we could have done better in the quarter, that is a pretty good EBITDA margin. If you look at the overall industry, you're going to find the overall industry is somewhere in the 12% to 12.5% range. And so I think that relative -- I mean I think you have to look at us relative to what the rest of the industry is doing, because frankly we aren't going to be able to defy gravity. So to the extent that advertising pages or consumer spending is weak, to the extent that there's really aggressive pricing that is oriented around fill volume today, we can't defy that gravity.

What we can do is frankly we can use the really strong platform that we have. We can take advantage of the fact that we have a strong balance sheet to be able to invest in the automation and the efficiencies where we can, and to be able to maintain that lead. I mean this is a really tough macro economy, it's a tough industry economy and we feel really comfortable and confident about our ability to compete in that. And despite the fact that we weren't happy with third quarter, we like our position coming out of the third quarter, whether you look at margin, whether you look at platform or whether you look at balance sheet position.

Okay. Thank you.

Scott Cuthbertson with TD Securities.

Good morning, Scott.

Yes good morning, Joel. Just a couple of questions. When-- about a year ago, I think books were sort of 8% of consolidated revenue, can you give us any indication of what that might be now, obviously maybe a bit less?

Yes, last time we looked at the picture I think was at the end of the second quarter, Scott, and it was at about 7% of the total business, that included Canada in the total. We'll frankly update that with our Q4 call, but we haven't done an update, but it was down from 8% to 7%.

Okay, thanks. 1 of the things that I noticed in covering another company that's a major publisher is they had a bit of a hiccup in their publishing business in their Q2. And this was driven by the nature of the business as it has existed historically, where you kind of print 100 books and ship 100 books to sell 50 and get half of them back as returns. And I guess probably as a result of the growing popularity of the eReaders and stuff, there was a bigger adjustment than normal in that quarter for that company. And that was kind of a one-time sort of adjustment, and going forward they have adjusted their shipping volumes and inventory expectations and their overall practices with the hope that they can kind of stabilize that and not have the same kind of shock in upcoming quarters. Is it -- are you experiencing anything like that, or is this an ongoing and pretty linear trend? Or was there any kind of sort of wakeup call in Q2 or Q3? I just want to get a little bit of color on the book problem and how we should think about it going forward.

Well there, this is Joel, there certainly was in the first half something that everyone saw, and that was in the retail world, we saw the disappearance of a major player, which was the Borders book company, and that took out a tremendous amount of volume out of the retail channel. And so they went into liquidation. Everybody had to kind of adjust to that. So that was a pretty significant impact to everybody. I think as you kind of go forward, certainly with all that is going on with the Kindle, you're going to see a lot of people playing with that technology and getting comfortable with it, and we believe it'll certainly continue to have an impact.

And I think as you look at how book companies look at their costs, I mean they do have a tremendous amount of money tied up in inventory. To print a bunch of books, and then have 30% returned is a painful situation. And so that's why I think you start to see people trying to get their batch sizes down. That's why we invested in some of the digital presses we did, because people want to start to do smaller batch sizes, so that they're managing that inventory down. So I think you're seeing a couple of things play out. But 1 of the -- I think the more I guess blunt thing that happened in the first half was that disappearance of Borders as a reset.

Scott, the other thing you're seeing within the book segment is that on the education books, down pretty significantly in 2011 with all the stress on the budgets at the state and local levels. So we've seen a pretty significant drop off in that and deferred adoptions.

Right, yes that makes sense, too. Thanks for that. Just the other thing that just kind of big picture was my impression heading into the quarter was that Q2 as a comp was kind of the last kind of wonky comp because of the unsustainable cost reductions that Worldcolor had undertaken in advance of completion of the merger. So I was kind of hoping that Q3 would be sort of a more normalized cost structure give that you had fully loaded costs in there including sustainable compensation practices et cetera. Is it fair to characterize the quarter like that, or was there a little hangover?

No, I think number 1 you have to remember that the-- we implemented the new compensation program as well as the new retirement program for the legacy Worldcolor employees on January 1 of 2011. So there were things that we had just closed the transaction, so we needed to take time in order to be able to do those right. So some of those less sustainable cost decreases frankly still carried through in Q3 of 2010.

The other thing is remember, Scott, that we announced the closure of the initial round of plant in August of 2010, but the actual transitioning of the 400 titles and the big uplift of the 25% volume in the receiving plants really didn't start until the fourth quarter of 2010. So really, we started to get some of the benefits in SG&A and procurement as far as the $15 million of synergies that we got in the third quarter of 2010. We didn't yet really have any productivity or frictional cost issues.

Okay, that's very helpful. Okay and the other thing I just kind of wondered, you talk about some of your new initiatives and how you're adapting. There was a couple of things like augmented reality in near field communications. I don't really understand what those were, I was hoping to get a little color on that.

Well it's-- if you're probably familiar with a QR code, or quick response code, you see them all over now. Where you can take a mobile phone and it recognizes this funky sort of square type of bar code and then launches you from that printed bar code right on your mobile app to someone's website or to a video that shows you how to use the product. That technology is I think, if you look at only a year ago, not many people knew what it is, now you walk down the street and you see it all over the place. Sort of where some of this mobile technology is going, it's going to the next level. So they're starting to use image recognition as a way to have the mobile device recognize something in print and then therefore at the same time bring down other content that works well with that print.

So like augmented reality would be where I take an iPad and I hold it over a printed magazine page, it recognizes that page, you see it as you kind of hold it over the page, the same page and suddenly a video comes into play. Or maybe it's a furniture catalog and you're selling lamps, up comes a floor plan of an apartment with those lamps placed throughout and you can actually physically interact with it, turn those lights on, turn them off to just see how you like it. And so again, I think that you're going to see a lot of evolution of how people use all of the different channels they have to market to their customers. And I think when you look at mobile, you look at online, you look at whatever, brick and mortar, I think everyone is looking to tie it together somehow, someway to make it convenient but yet very impactful for their customers and that's what that is.

And near field communications is actually putting down sort of a printed chip that the newer cell phones are able to-- you're able to just hold it up to wherever that chip is and it will then direct you to wherever they want. So it's neat stuff. It's just another step in the ever-evolving use of the multi-channel world and we think it's pretty exciting because it really keeps print as a part of that base.

Okay, thanks. Last one I'll ask is just a quick one for you, John. You say you got a 1-year payback on the refinancing and I just wondered the one-time treasures associated with that refinancing, are those amortized over the deal or are they going to hit Q4 or were they in Q3 or were are they buried in the $34 million charge, just wondered?

Well the accounting as often stated gets to be rather complicated, so essentially you end up with a blend of the refinancing costs in 2010 and 2011 including the OID and essentially $34 million was written off. I think the total was approximately between the2 years financing including OID was about $46 million, and the balance will be amortized over the 5-year period of the revolver. So it'll be a relatively small number, Scott.

So it's not really going to push --

Right, no and as you know, we were very fortunate that it hit the timing of the market really well and we have a great group of supporting lenders, both in the bank market and the term loan B market, so that's a big savings. And frankly, a real strengthening of the balance sheet to have those longer maturities and the structure that's contained therein.

Okay. Thank you.

Dan Leben with Robert W. Baird.

Good morning, Dan.

Good morning, guys. First off, for John, I want to get a little clarity on 2 numbers you gave. 1 was in the slide deck, the $25 million lower incentive comp versus the $10 million you talked about, was the $10 million reversal of accruals from the first half, is that what that number was?

Correct. And the $15 million was the incremental incentive comp that we recorded in the first quarter of the ownership of Worldcolor in third quarter of 2010.

Okay, great. And then just to jump over, within mag/cat that business, were your volume declines in line with the overall industry or were those a little bit higher because of your disciplined approach to pricing?

No, I mean our-- I'd say when we look at -- there was nothing usual for us happening in mag/cat. I don't think you can take the ad pages and necessarily equate them to what we're seeing. We haven't been breaking out the volume by individual segment. But I'd say that what we were experiencing was what the rest of the industry was experiencing, as far as overall volumes being impacted in the quarter.

Okay. And then as we progressed through another month in October and early November, the visibility you have into the rest of the fourth quarter, has there been any change in pace, either direction, with respect to that business?

We continue to -- Dan, the challenge we have is there just isn't a lot of visibility when we talk to our customers, they really don't know kind of month to month exactly where their ad pages are going to be, they move around. Same thing, they'll make significant adjustments in their catalog and retail programs. I don't think we've seen anything that's dramatic. Clearly, we're concerned that with all of the events that are taking place, and the macro economy, that it's going to have an impact on print volumes.

Okay. And then in relation to the Canadian assets, any update on timing for when that deal should be completed?

We're going through the normal course with the regulators up there and we expect-- we're fully compliant, we expect the process to move along. But we can't speak for them in terms of when it will be finished, but we expect it to not last forever here.

Okay. And then last one for me, just what was the contribution from the businesses that did close, the Mexican and US assets, what was the contribution within the quarter?

The contribution in the quarter was a little bit less than $1 million. But we continue -- frankly, we've owned that business now for 2 months, we got a great integration team put together that blends people that worked on the integration of Worldcolor as well as the Mexican team. And the good news is we continue to feel very comfortable that -- in that 12 to 18-month period we're going to get to the $20 million to $25 million of EBITDA of the combined businesses that we talked about when we announced the deal. And they've been working on being able to do that more efficiently. And initially Dan, we had shared that we thought that the cost to achieve and related CapEx would be $20 million to $25 million, we now think with the plan that they've presented to us and that they're in the process of implementing, that number will be about $15 million to $20 million, so about $5 million less. So that is moving very well.

Okay, great. Thanks, guys.

You're welcome.

There are no further questions at this time. I would like to turn it back over for any closing remarks.

Okay, thank you all for participating today. While our results this quarter did not meet our expectations, I am confident that we are taking the right actions to manage our cost structure, conclude the integration successfully and position our Company for the future. This is one of the most complicated integrations the industry has ever undergone and we are doing it during a very challenging economic time. The efforts of our employees have been nothing short of amazing. And we appreciate all the good work being done. We have a strong balance sheet with very strong free cash flow. That financial strength combined with our strategy to continue to create value for our customers through innovative print solutions and supported by our committed employees worldwide will help move Quad/Graphics successfully into the next 40 years. So thank you all for joining us today.

Thank you, all, ladies and gentlemen, for your participation. You may now disconnect.