Quad/Graphics Inc (QUAD) 2013 Q3 法說會逐字稿

Good morning ladies and gentlemen thank you for standing by. Welcome to the Quad/Graphics third quarter 2013 conference call. During today's call all the parties will be in the listen only mode. Following the speakers presentation the conference call will be open for questions.

(Operator Instructions)

I will now turn the conference over to Mr. Kelly Vanderboom, Vice President and Treasurer for Quad/Graphics. Kelly, please go ahead.

With me today are Joel Quadracci our Chairman, President, and Chief Executive Officer; John Fowler, our Executive Vice President and Chief Financial Officer, and Dave Honan, our Vice President, Corporate Controller and Chief Accounting Officer. Joel will lead off with key highlights for the quarter, John will follow with a more detailed review of our financial results, followed by Q&A. With the exception of certain debt ratios, prior year financial results do not include the acquisition of Vertis. All actual 2013 results include Vertis from the day of acquisition on January 16, 2013.

I would like to remind everyone that this call is being webcast and forward-looking statements are subject to Safe Harbor Provisions as outlined in our quarterly news release and in today's slide presentation. Our financial results are prepared in accordance with generally accepted accounting principles, however, in addition to financial measures prepared in accordance with GAAP, this presentation also includes non-GAAP measures including adjusted EBITDA, adjusted EBITDA margin and recurring free cash flow.

We have included in the slide presentation, a reconciliation of these non-GAAP financial measures to GAAP financial measures. The slide presentation can be accessed through a link on the Investor Relations section on the Quad/Graphics website. 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 concludes today.

I will now turn the call over to Joel.

Thank you Kelly, and good morning everyone.

We are pleased to begin our call this morning by reaffirming 2013 annual guidance for recurring free cash flow in excess of $360 million. Our ability to generate significant recurring cash flow is the foundation of our strong balance sheet, and provides us with the ability to execute our disciplined capitol deployment strategy. As always, we remain flexible and opportunistic in terms of our future plans for capitol deployment, which includes balancing our key priorities to pay down debt and pension liabilities, invest in our business, pursue future growth opportunities, and it return value to our shareholders.

While volumes in our US platform were as expected, we did face challenges during the quarter that impacted our results, primarily related to ongoing industry pressures, economic and political challenges in Latin America and the slower than expected turnaround in the underlying Vertis business. That said, the Vertis integration process itself is going well.

As far as the Vertis integration, we are 9 months into multi-year process with many moving parts, and I'm proud of the work our employees are doing to advance the integration and achieve our objectives. We hit the ground running in January, focusing on rebuilding and moving equipment, installing IT systems and training our newest employees -- including providing sessions on our corporate culture and how we use our values to drive our business decisions. Our integration goal was to accomplish as much as possible in the first 6 months of the year before ramping up operations for the busier second half of the year, a critical time when we need all hands on deck to make volume requirements.

We made good progress, however, during the quarter we face challenges related to the lower than expected turnaround in the underlying Vertis business which impacted topline results in productivity. From our topline perspective, Vertis' ongoing financial stress created issues with client retention prior to the acquisition. I'm pleased to report that we are beginning to see an number of clients return work and we are overall optimistic about where we are headed with our direct marketing business and opportunities in the marketplace.

From of productivity perspective, the challenges were primarily related to equipment breakdowns, cost by history of deferred maintenance across the Vertis platform. Although fixable, these equipment challenges will simply take longer to correct. Overall, we are very satisfied with their decision to acquire Vertis, which expanded our position in retail inserts, direct-mail, in-store marketing, and media planning and placement, and brought us many talented employees who are committed to serving our clients well. We remain confident in our integration process to direct future cost savings, and improve the efficiency and productivity of our platform.

Looking to Latin America, our quarterly results were impacted by economic and political challenges. Mexico, for example, is experiencing an economic slowdown that has weakened GDP growth. According to Reuters, GDP growth is projected to be only 1.2% in 2013, down from 2.9% expansion forecast in July, and lower than the 3.8% growth experienced in 2012. Brazil too, continues to struggle. The economy expanded only by 0.9% last year, and is battling stubbornly high inflation.

In Argentina, supply constraints and political uncertainty continue to restrict economic activity, putting negative pressure on our business. These challenges aside, the economies in Colombia, Chile and Peru are solid, and operations are performing well. And overall, we are pleased with the strength of our continent-wide platform. We continue to believe that Latin America is a great long-term opportunity for us, and we will adjust accordingly for the current realities of the marketplace.

We take great pride in being in printer an innovator, and one area in which we have pioneered many cost saving solutions for us in our US clients, is in mailing and distribution. As I discussed on last quarter's call, the US Postal Service is under extreme financial pressure. This has created an urgent need for postal reform so that printed mail remains the strong and practical option for marketers and publishers. Sweeping reforms, including giving the USPS the authority to right size its operations for the realities of projected volumes, are necessary, because price increases alone cannot fix its budget problems, and may actually hurt the USPS over the long-term.

It remains uncertain if Congress will pass meaningful postal reform legislation before year-end, and because of that, the USPS felt it had no choice than to file for a 4.3% exigent increase. This increases well above the annual CPI increase of 1.6%, and if approved, the total impact to mailers would be 5.9%. The postal rate commission has until year end review the proposal and make its decision. I've been actively involved on Capitol Hill voicing our concerns that any increase above the CPI has the potential of impacting future postal volumes. But regardless of what happens with the rates, we remain committed to developing innovative postal solutions that lower our clients' overall cost per piece.

The spirit of innovation directly connects the two distinct ways that we create client value. One by helping maximize the revenue our clients derive from the marketing spent through media channel integration, to help drive response across all marketing channels. And two, by helping minimize our clients' total cost of production and distribution. Our mailing and distribution capabilities are big part of how we help our clients reduce costs, and we have built a leading platform with capabilities and volume second-to-none in the industry. We believe this gives us the long-term sustainable advantage versus our competition.

For example, our Co-Mail solutions combined multiple clients' magazines or catalogs into a single mail stream that then qualifies for greater postage discounts. The savings are further enhanced by our extensive dropship program, in which we deliver mail to the USPS processing facility closest to its final destination. Finding innovative ways to reduce cost is not only important to our clients, but also to us as an employer. One area in which we've been able to significantly reduce our own cost is through our approach to healthcare management.

We launched QuadMed more than 20 years ago, to improve our companies access to high-quality cost-effective healthcare, with on-site clinics and workplace wellness programs. Our approach transformed us from a purchaser of health insurance to an investor in employee health productivity through wellness and disease prevention. Given the success of our model, we now provide healthcare management solutions to an number of Fortune 1000 companies. And soon, we will close on or $13.5 million acquisition of NoviaCare Clinics, an Indianapolis-based healthcare solutions company, that specializes in developing and managing on-site and shared primary care clinics for small and medium-sized companies.

Novia's approach to employer-sponsored healthcare solutions compliments are QuadMed model, which excels at serving larger companies with a national presence. This acquisition is an exciting growth opportunity for QuadMed because it will strengthen QuadMed's offering with the continuum of services designed to meet any employer's needs regardless of industry segment, size or location. With Novia, QuadMed will grow to more than 90 clinics in 18 states, and save more than 150,000 lives. Further, as an employer, we will use our expanded healthcare delivery platform to partner with other employers, to create shared clinics which will create value and additional cost savings for our Company.

Given our commitment to innovation, along with our disciplined approach how we run our business, we are competent in our ability to create value for shareholders, and maintain an exceptional workplace for our employees. With that, I will handle the call over to John for detailed review of our financials.

Good morning everyone. Slide 4 is a snapshot over third quarter 2013 financial results, including Vertis, as compared to our third quarter 2012 results. As a reminder, our 2012 results do not include the acquisition of Vertis, which occurred on January 16, 2013.

Net sales were $1.2 billion as compared to $1 billion, representing the 16% increase due to the Vertis acquisition. If we look at the Vertis business, as if we acquired at the beginning of 2012, our pro forma consolidated net sales declined approximately 7%, of which we estimate Vertis represented approximately one-third of this decrease. The remaining two-thirds of the decline related to our core business, and reflected topline challenges from ongoing industry pressures and economic and political challenges in Latin America. Overall, this variance is in line with our net sales expectation for both the quarter and the year, inherent in the lower end of our guidance range.

Cost of sales was up $950 million as compared to $798 million. SG&A expense was $102 million as compared to $87 million. Depreciation and amortization was $82 million as compared to $83 million. Restructuring, impairment and transaction related charges were $28 million in 2013, which included $9 million of non-cash impairment charges. In comparison, restructuring and impairment and transaction related charges were $12 million in 2012, and included a $13 million non-cash curtailment gain resulting from an amendment to the post-retirement medical benefit plan. Excluding the non-cash amounts, restructuring, impairment and transaction related charges for the third quarter decreased from $25 million in 2012 to $19 million in 2013.

Interest expense was $21 million as compared to $22 million, our adjusted EBITDA was $154 million as compared to $155 million, and our adjusted EBITDA margin was compared to 12.8% as compared to 14.9%. Our adjusted EBITDA margin reflects a number of factors that include ongoing industry pricing and volume pressures, including volume and productivity in our book business, Vertis' historically lower margin profile, economic and political challenges in Latin America, and challenges with the Vertis turnaround.

Slide 5 is a summary of our 2013 guidance. Now that we are through the third quarter, we feel comfortable narrowing our guidance for net sales and adjusted EBITDA. We anticipate full year 2013 net sales to be approximately $4.8 billion, narrowed from a prior guidance range of $4.8 billion to $5 billion, and adjusted EBITDA to be approximately $580 million narrowed from a prior guidance range of $580 million to $610 million.

As Joel communicated, we are pleased to reaffirm our recurring free cash flow to be in excess of $360 million, and we remain confident in our long-term outlook to generate future recurring free cash flow and value for shareholders. We anticipate full year 2013 capitol expenditures to be at the low end of our guidance range of $150 million to $175 million, cash taxes to be approximately $40 million up from the previous guidance of $25 million to $30 million, and pension cash contributions, which include single-employer pension and post-retirement plans to be approximately $40 million, down from the previous guidance of $45 million. All remaining guidance numbers are as previously reported.

For the first 9 months of 2013, recurring free cash flow was $178 million, as compared to $220 million for the same period in 2012. The variance is due to increase capital expenditures and lower net cash earnings during 2013. The increase to capital expenditures is primarily due to the 2012 rollover of projects, and our efforts to finish critical capital projects before the start of the busier second half of the year. We define recurring free cash flow as cash flow from operating activities, which include pension contributions, less capitol spending, and excluding nonrecurring items such as restructuring and transaction-related costs. We believe this is an important metric for us, and we expect our best to continue to generate any significant amount of recurring free cash flow.

At September 30, 2013, our interest coverage ratio is 6.8 times as compared to 6.7 times in December 31, 2012. Our quarter end leverage ratio of 2.69 times reflects the impact of the Vertis acquisition and our peak season for working capital. Our consolidated debt and capital leases increased $187 million from 2012 year-end, due to the additional debt required to fund the January 2013 Vertis acquisition. We continue to believe that operating in the 2 to 2.5 times leverage range is the appropriate target, and we expect to return to a leverage ratio of approximately 2.5 times by year-end. However, we acknowledge that, at times, we may go above or below that range, given economic changes, working capitol seasonality, timing of investment such as the Vertis acquisition, and growth opportunities.

Our strong, annual recurring free cash flow provides us with the ability to pay down our debt and pension liabilities, invest in our Business and return capitol to our shareholders. Since the close of the World Color acquisition on July 2, 2010, and after funding the Vertis acquisition, we have paid down a total of $257 million through September 30, 2013. As it relates to our pension liability, we are proud of the progress we continue to make in reducing the pension and post-retirement liabilities that we assumed as part of the World Color acquisition.

From our July 2, 2010 acquisition date through September 30, 2013, we have reduced the $547 million of assumed pension and post-retirement liabilities by $213 million. Further, using the current increase discount rates, and strong year-to-date asset returns and fourth-quarter cash contributions, we estimate the pension and post-retirement liabilities will decrease an additional $100 million by the end of 2013.

At the top of slide 7, you will note that we $308 million of borrowings under our $850 million revolver as of September 30, 2013. Our floating rate debt today is an average interest rate of 2.9%. The long-term fixed-rate debt, consisting of private placement bonds, is at an average interest rate of 7.3%, and has an average maturity of 10 years with the weighted average life of 6 years. The blended interest rate on our total debt is 4.4%, and the outstanding principal balances are 65% floating, and 35% fixed. We have no significant debt maturity until July 2017.

Given the flexibility under our revolver, and our strong recurring free cash flow, we believe we have sufficient liquidity for current business needs, returning cash to shareholders, and investing in opportunities that will drive future value. Our quarterly dividend of $0.30 per share will be payable on December 20, 2013, to shareholders of record as of December 9, 2013.

I would now like to turn the call back to the operator who will facilitate taking your questions. Operator?

(Operator Instructions)

Our first question comes from the line of Haran Posner.

Starting with volume picture in the US segment, I guess, in your commentary you mentioned that the print volumes in the US were as expected. You did point out that there were still industry pressures, I was just curious, should we read into that, that there is any change on the pricing dynamic this quarter?

I can give you some color just on what's happening in volumes for the different segments we are in. You know, I would say that from a magazine standpoint, in overall industry ad pages, we are probably down about 1.8%. I would say, we probably saw, actually, a little bit of an increase, however, I think, they are also managing their ad/edt ratio more tightly. So in other words, the ad page isn't the whole story, but it's more stable story that we are seeing from a catalog standpoint. We are probably seeing just the little bit under 1% decline, for us, in the industry, maybe about 2%. So fairly stable as expected.

And, if you recall, we always talked about pricing declines of about 1% to 2% and volume about 2% to 3%, so those trends are what we continue to see. However, I will say, that on the pricing side, we are seeing the 1% to 2% creep higher, in terms of towards the higher end of that level, not above 2%, but not closer to 1%. And when you think about volumes here, for the industry, that stuff is easier to deal with. For instance, as we've done the various acquisitions that we've done, whether it's Vertis or WorldColor, we have shored up the most efficient platforms and taken out excess capacity, and we have closed over 19 facilities or 6.7 million square feet. And actually, if you take into account the assets we didn't take in Vertis, which through the asset bankruptcy, was almost 23 facilities.

So, that part, I think, that the industry can manage if they have the discipline to take the capacity out. The pricing is the part that harder for the industry to offset, that's where you really have to focus on best in class cost take-out. And 1% to 2% doesn't sound like a big number, but it actually is. Again, we focus a lot of efforts through lean manufacturing, changing the platforms, to all the things that we do with distribution to try to offset that impact. But again, we continue to see both things in the range but we have talked about, with pricing just edging up a little bit.

That's terrific color, Joel, thanks for that. When I looked into 2014, I guess, correct me if I'm wrong, but, I believe you would have the extended contract you signed with Time, with the magazines there, that should be a bit of a tailwind on the revenue front. I'm just wondering, first, if you can confirm that, and if there is any other renewals that are, sort of, major that we should be thinking about looking at into next year?

Well, we are in the middle of our planning for 2014, and some of that is really predicated on our customers feeding us their plans for 2014. So that process is really, kind of, happening as we speak. It's true, yes, we have a good contract coming on board with Time Inc., we have a few renewals, we don't Tout everything that we do, and there is ebb and flow in the portfolio, which is pretty normal. So, until we can get into our 2014 planning, it is hard to give color on where we see it. It's a great win, I mean, that Time Inc., thing. We are pleased that they, basically, opted to single-source with us which is-- the company had never done that before, but we have a huge portfolio of customers, and we are renewing a lot of things, and it's challenging market out there.

Absolutely. Thank you for that. Shifting to John, just in terms of working capital, obviously a big draw in Q3, seasonally high. But just curious, for me to square off, your free cash flow guidance for the year, I kind of have to assume there is the big reversal of that in Q4. I was wondering if you could help us at all, with modeling that line for the year?

Well, I think that two of the three quarters, Haran, we had working capitol consumption of $4 million, which was the combination of $81 million of working capital consumed, against $77 million of the restoration of normalized accounts payable as the result of the Vertis acquisition. So we had a lot of noise. Historically, our working capital peaks between September 15 and the end of-- the middle of November, and then starts moving down. So yes, we would expect to be generating free cash flow from working capital during the fourth quarter by the end of the year. And, that is the assumption that is inherent in our affirmation of the guidance in excess of $360 million on the recurring free cash flow. And that is historically what we have seen. The only thing we have seen unusual in 2013, is this restoration of the normalized Accounts Payable as a result of Vertis.

That is perfect. And maybe just one last one, with respect to CapEx, Johnny got into the lower end of the range, I think in your early comments with respect to productivity at the Vertis, it sounds like, maybe, they under-invested in their platform before. Is that something we should think about with respect to your CapEx outlook, or is it not overly material?

I don't think, Haran, I don't think it is going to impact our CapEx. But what we have seen, based upon the challenges and the turn around, and, frankly, challenges in the platform, is, really, around the deferred maintenance. And originally, our expectation of the acquisition was that we were going to generate synergies in excess of $50 million. We still feel comfortable with that. Our original anticipation was that we would have about $1 of cost to achieve for every $1 of synergy. We think that number is going to be more in the range of $1.25 to $1.50 per $1 of synergy that's generated, so that's where we are going to see it, not in the CapEx, but in the one-time restructuring and impairment.

Having said that, even with the challenges and the turnaround of the underlying business, and some of the challenges in the platform, we continue to feel really good about the acquisition, in the sense that, the strategic fit is working out as we expected it to, as Joe indicated, the integration process itself is going well. And from an economic point of view, even taking the cost to achieve up into the $1.25 to $1.50, our cost of the acquisition post-integration, it is still going to be less than three times as far as the purchase price.

And, Haran, this is Joel, let me add a little bit of color on when we talk about the platform turn around. You remember, we closed the deal, what, the second week of January, so we had a period of time where we had to move quickly to do what we call baselining the equipment. So, in an environment where people have under-invested in, it's not the big heavy equipment in terms of building more, it's actually just in terms of the daily maintenance that they pull back on. And these are complicated pieces of equipment with lots of gears and things like that, and so, to baseline a printing press, you are literally somewhat tearing it apart and then rebuilding it back up, and that takes time out of the production schedule. So, we can only do so much until we get to the busy season when we need everything running whether or not it has been baselined. When you are in a busy season, everything is running hard, and it is not-- under-invested equipment, from a maintenance standpoint, is not the problem-- the problem is not in the late season, it's in the heavy season, because things break when you don't want them to and it's costly to move work around to make up for that. And so that is what we are experiencing and it will take a little bit more time here to continue to do those baselines, because we can do it in-- only in open windows, where we are not expecting higher volumes like you do in the third and fourth quarter for retail. Does that help?

Yes, for sure. Super, thanks very much Joel.

Thanks, Haran.

Our next question comes from the line of Charlie Strauzer.

Good morning, Charlie.

Good morning. Joel, if we could talk about some of the issues you are having with the integration of Vertis, and maybe explain a little bit more about what steps are being taken to, kind of, fix those, and what are the stumbling blocks that you have incurred to date?

When you think about Vertis, you have to think about there is the integration and then there is the underlying business. So, the integration, which you, kind of, think about of merging your IT systems, rolling out culture, which in our case, is things like uniforms, but also hoping our new partners to understand how our culture works so they can get things done, HR policies, all the stuff from an integration standpoint is going well. We are pleased with where that's going. But when you acquire a business that has going through bankruptcy, which turned out to be three times, it is a turnaround by definition. And so the underlying business, is what we have talked about, has been a challenge. And that is why I refer to making up for deferred maintenance, and then, when you think about the topline part, so it is the platform and the topline, that you think about when there is a company that is going through financial challenges.

And you remember that Vertis has two product lines, primarily, which is, the retail answer and transactional direct mail. On the retail side, it's about as expected, from a topline standpoint. We had some ebbs and flows with some customers wanting to, if they had 100% position before, looking at the bankruptcy saying, maybe we should pull a little bit out, but generally speaking, topline is where we expected it. On the transactional side, which is the direct mail side, you have to remember, these are not longer-term contracts, they are usually seasonal and even drop-in. That's where we saw more of the pressure on the topline, because people could pull the work.

And we had some significant customers that started pulling the work before the transaction was even done, which we knew that that was going to happen. But then it takes time to win them back, because they ordered-- sometimes, at a season at a time. We are starting to see some of those long-term clients who did reduce their work starting giving us work back, but that takes time and it takes effort. We have done a lot of work on the sales front, in terms of merging the two groups, opening up the opportunity for direct mail to our other verticals. And, some of that stuff is not a light switch, but it takes time. So to summarize, it really-- you got to think about the integration, itself, is going well, the underlying turnaround of a challenged business is just taking longer than we would have liked, but we are putting out all stops to continue to do what we are doing.

And Joel, when you talk to those direct mail customers, some of the larger ones, is it more of just a-- they are pulling back because of, certainly, maybe, with the political environment, what happened with Congress, or is it just they are not sure where the economy is going? Or are they, you are getting a little more comfortable now and saying, okay, you know what, we are going to dip our toe back in the water again and start giving you guys some volume?

Actually, from an industry standpoint, the direct mail story is more of a growth story, so we are not seeing an impact because of the political environment. The fact of the matter is, direct mail works. Where we have seen some strong vertical performance in the industry now, is in things like mortgage, credit cards, banking. Those are areas that got hit pretty hard in the past, but they realized that it works. And what's really growing in direct mail is the heavily personalized, in-line finished product line, and that's really the strength of what our platform does. And some of that, when it got pulled way out of concern about more-- just-- the Vertis bankruptcy, we replaced a lot of that volume, but it was with the more generic direct mail volume, that doesn't require all the bells and whistles, and therefore, has a different price mix and not as much value added. So as we continue to push on the sales front and making sure we have all the right things, the platform is looking beautiful, by the way, on the direct-mail side, but the sales efforts to now bring back that higher complex direct mail stuff is really the focus of what we have going on here.

Switching gears a little bit to some of the other parts of the business, where, maybe, you saw some organic growth in the quarter. And, maybe, you can maybe highlight a little bit more about those items and what you are seeing, kind of, visibility-wise there.

I think I, sort of, went through some of that in the last question just talking about, you know, we continue to always say that there's about a 2% to 3% degradation in the industry volume if you look at it across the whole system here. We have seen of little bit less than that depending on the category you're in. Ad pages for magazines were actually up in our mix, catalog was slightly down, and again, we are down in direct-mail but the industry is actually up, and retail is, we have experienced, as-expected volumes.

So, I think, it really depends on the category, but we're not-- I think, there's always a lot of concern in this industry about where is volume going to go and if it can accelerate. And, I think, on the good news category, is we are not seeing that. We are seeing stabilization in some of the categories. But I will point you back to the challenge the industry will continue to have, is the pricing. And that is where we have seen it within the range of the 1% or 2%, but it is actually edged up a little bit towards the higher end of the range, and that's where the industry needs to figure out how to offset those costs.

And Joel, how much do you think the Postal Service turmoil has impacted some of the other pricing as well?

You know, I'm not sure it impacts the pricing, I think it more is going to impact how people think about volumes. It's not the only factor. I think, people, like cataloguers and direct-mail, see their businesses improving, they are going to continue to use the mail because that is where they drive a lot of the transactions. But when you talk about this exigent case, again, if you go back in time here, the last postal reform capped any kind of increase the post office could do at the change in CPI per year. But, they had the underlying clause in it that that said, if they couldn't offset their cost and it was an extreme situation, which by the way, the current exigent case is claiming the extreme situation is the recession back in 2008, on why they want to increase rates in 2014, and so they are being challenged on the legitimacy of that.

But we are talking about a 5% plus potential increase in our customers' largest costs. To me, that is probably the bigger factor in terms of what the post office is going to have an impact on, rather than pricing. Pricing is purely the industry and not having the discipline to pull capacity out, that we have, as we have consolidated. And so, I think, you will continue to see that play out, and our focus is, you know, to be best in class and make the disciplined decisions on, whether it's market share-- because market share at any cost does not make sense. We believe in the disciplined approach to pricing that allows me to look at my investors and employees and say, that the work you are doing is sustainable at these pricing levels. And, I think, you are seeing in the industry, there is some fallout happening where people are going beyond that, and it's just not sustainable. So we have to balance the defending market share with market share at any cost, and we will continue to be very disciplined about how we approach that.

Great, thank you very much.

You are welcome. Operator?

There are no further questions at this time.

Okay. Thank you all for joining us. We continue to be very disciplined in our approach in running this Company. I'm actually pleased with our employees and how they are facing the headwinds, but the headwinds do exist, and we will continue to manage hard to try to offset that.

We will see you again in February. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.