Quad/Graphics Inc (QUAD) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Quad/Graphics Second Quarter 2017 Conference Call for Analysts and Investors. (Operator Instructions)

A slide presentation accompanies today's webcast, and participants are invited to follow along, advancing the slides themselves. To access the webcast, follow the instructions posted in last night's earning release. Alternatively, you can access the slide presentation on the Investors section of Quad/Graphics' website, under the Events & Recent Presentations link in the left-hand navigation bar. Following today's presentation, the conference call will be open for question. (Operator Instructions) Please note this event is being recorded.

I would now turn the conference over to Kyle Egan, Quad/Graphics' Manager of Treasury and Investor Relations. Kyle, please go ahead.

Thank you, operator, and good morning, everyone. With me today are Joel Quadracci, our Chairman, President and Chief Executive Officer; and Dave Honan, our Executive Vice President and Chief Financial Officer. Joel will lead off today's call with highlights of our financial results, along with discussions of our company's ongoing strategic transformation. Dave will follow with a more detailed review of our second quarter 2017 financial results, followed by Q&A.

I would like to remind everyone that this call is being webcast, and forward-looking statements are subject to safe harbor provisions, as outlined in our quarterly news release and in today's slide presentation on Slide 2. Our financial results are prepared in accordance with generally accepted accounting principles. However, this presentation also contains non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, free cash flow and debt leverage ratio. We have included in the slide presentation reconciliations of these non-GAAP financial measures to GAAP financial measures.

A replay of the call will be available on the Investors section of our website shortly after we conclude today. The slide presentation will remain posted on Quad/Graphics' website for future reference.

I will now hand the call over to Joel.

Thank you, Kyle, and good morning, everyone. I am pleased to report that our second quarter 2017 results were in line with our expectations as we continued to execute on our strategic objectives. Despite ongoing industry-wide top line pressures, our adjusted EBITDA margin increased compared to the same period in 2016. In addition to our ongoing focus to reduce debt, our debt leverage ratio is at the lowest point since 2012.

We remain disciplined in how we manage all aspects of our business, with a concentrated focus on improving productivity and sustainably reducing costs to drive EBITDA enhancement while remaining focused on top line revenue. We believe this focus will minimize the impact of ongoing industry and economic pressures and help Quad/Graphics remain the industry's high-quality, low-cost producer. We also continue our focus on generating sustainable, strong free cash flow to strengthen our core platform to ensure it remains the strongest and most sustainable in the industry, return capital to shareholders through our quarterly dividend and support our continued transformation to help clients market their products and services and content more efficiently and effectively.

We refer to our transformation as Quad 3.0, which reflects our evolution from a start-up printer that grew rapidly in Quad 1.0 to a disciplined industry consolidator in 2.0; and now in 3.0, to a global marketing services provider that leverages our strong print foundation in combination with our deep expertise in workflow reengineering and optimization, content management and data-driven marketing, including personalization across all media channels. Our transformation creates significant value for our clients by addressing their urgent business needs to improve process efficiencies and marketing spend effectiveness.

Quad 3.0 leverages the seismic shift in today's business environment that are driving marketers and publishers to create more content at a faster pace with fewer resources, and then orchestrate that content across the right mix of media channels at the right time, often with the added complexity of having to use multiple agency partners. This climate has created an opportunity for Quad to further our role as a marketing services provider and help clients to simplify how they operate within their own organization to save time and money and sell more of their own products, services and advertising by improving marketing spend effectiveness through data-driven marketing across all channels.

When it comes to helping clients simplify how they operate, we capitalize on Quad/Graphics' deep operational and business process expertise to conduct client workflow discovery and process optimization programs. These programs are managed by knowledgeable Quad/Graphics employees, including many with client-side experience, who examine workflow from the initial strategy through final output to any channel. As a result, we identify opportunities to reduce cycle times and save money through eliminating redundancies. Using our scalable solutions, clients are able to create more content for more channels faster with fewer resources and iteratively revise that content quickly based on consumer behavior. In other words, Quad 3.0 allows clients to compete more aggressively today while addressing tomorrow's changing market demands.

Increasingly, marketers, publishers, retailers and brand owners are taking notice of our differentiating value in Quad 3.0. For example, as we announced last week, National Geographic Partners has joined our growing list of clients using our upstream efficiency-focused services. Under a new multiyear, multimillion-dollar contract, Quad/Graphics will manage National Geographic Partners' comprehensive production services, including paper procurement, prepress and printing management using some of National Geo's talent, who will be hired as Quad/Graphics employees. As part of the agreement, National Geographic Partners extended the term of our printing arrangement.

National Geographic Partners joins a growing list of publishers that have engaged Quad/Graphics for production services. Other publishers include Cengage, Forbes, Outside Magazine, Rodale, The Week, and Wenner Media, among others. In addition, Quad/Graphics provides production services as well as other content creation and content management services for approximately 30 marketers and retailers, including Bluestem Brands, Cabela’s, L.L.Bean, Staples, Tractors Supply and more.

Quad/Graphics' upstream services are driving substantial downstream revenue in all our print product lines and other services. Clients recognize Quad as the only printer and marketing services provider that has the depth of upstream services combined with downstream outputs that can be executed in an integrated fashion. We are confident in our strategy, which further differentiates our offering and better positions the company for long-term success.

As we continue to enhance the value of Quad/Graphics as a marketing services provider in Quad 3.0, we will build on our strong foundation to help improve both the execution and effectiveness of our clients' marketing campaigns across print, digital and other channels. To accelerate this vision, we have added specialized talent to our team, including individuals with client-side and agency experience, data experts and professionals with deep knowledge and experience from other parts of our industry. In addition, we continued to lever our strategic partners with Rise Interactive, a digital marketing agency that specializes in media, analytics and customer experience. This partnership combines Quad expertise in optimizing clients' marketing spend in offline channels with Rise's expertise in online channels to create more powerfully integrated campaigns in addition to all the other services we already provide. When combined with expertise of our BlueSoho multichannel agency, clients have a robust and comprehensive partner in Quad to help them improve their marketing and sales results.

With that, I will now hand the call over to Dave.

Thanks, Joel, and good morning, everyone. We're pleased to report that our financial results for the first half of 2017 are in line with our expectations, and we continue to remain on track to delivering our full year 2017 financial guidance.

Slide 4 provides a snapshot of our 2017 second quarter and year-to-date financial results as compared to 2016. Net sales for the 3 months ended June 30, 2017, were $963 million, down 6.7% from 2016. Organic sales, which exclude pass-through paper sales and foreign exchange impacts, declined 4.8%. Pass-through paper sales were down 1.7% in the quarter, and foreign exchange losses impacted sales negatively by 0.2%.

Net sales for the 6 months ended June 30, 2017, were $2 billion, down 5.4% from 2016, with an organic sales decline of 3.7%. The quarter and year-to-date organic sales declines were due to ongoing industry volume and pricing pressures and remain in line with our annual sales guidance assumption, which anticipated volume declines in the range of 1% to 4% and a price decline in the range of 1% to 1.5%.

Adjusted EBITDA for the 3 months ended June 30, 2017, decreased $1 million to $97 million as compared to $98 million in 2016. And our adjusted EBITDA margin increased 50 basis points to 10% compared to 9.5% a year ago. Adjusted EBITDA for the 6 months ended June 30, 2017, remained flat with 2016 at $218 million, while our adjusted EBITDA margin increased 60 basis points to 11.1% compared to 10.5%, primarily driven by cost reductions and productivity improvements. Included in these lower costs are a $5 million gain from a property insurance claim during the second quarter and $7 million of net year-to-date nonrecurring benefit from a $17 million reduction in our vacation accrual in 2017, partially offset by a $10 million onetime benefit realized in 2016.

The company generated $69 million of free cash flow for the first 6 months of 2017 compared to $179 million in 2016, representing $110 million decrease between years. This decrease was expected and was primarily driven by a $64 million reduction in the benefit from our controllable working capital improvement program. Year-to-date benefits from the controllable working capital improvement program totaled $32 million in 2017 versus $96 million of benefits in 2016. This decrease in benefits from working capital was expected and was reflected in our annual free cash flow guidance that we set at the beginning of this year for 2017. Additionally, free cash flow decreased due to $46 million in net impact from reduced employee liability and lower cash payments for restructuring.

As a reminder, we generate the majority of our free cash flow near the end of the third quarter and into the fourth quarter of any given year due to the seasonality of our business, and we remain on track to achieve our full year 2017 annual free cash flow guidance of $225 million to $275 million.

We believe we have an industry-leading free cash flow conversion rate. Free cash flow conversion represents the amount of free cash flow generated from every dollar of adjusted EBITDA, which, in our case, is over $0.50 of free cash flow for every dollar of adjusted EBITDA we earn. This efficient generation of free cash flow has allowed us to pay down a significant amount of our debt, which is highlighted on our next slide.

Slide 5 includes a summary of our debt capital structure as of June 30, 2017. We continue to remain focused on strengthening our balance sheet through debt reduction. Since December 31, 2015, we've reduced debt by $272 million or 20% and finished the second quarter with just under $1.1 billion in debt and capital lease obligations, which is our lowest level of debt since we became a public company.

Our free cash flow generation through the first 6 months of 2017 drove $53 million of additional debt reduction and resulted in improving our debt leverage ratio to 2.25x. We continue our focus on debt and pension reduction as the primary use of cash, and we believe that operating within our consistent long-term leverage range policy of 2x to 2.5x is the appropriate target. As a reminder, we may operate outside this range depending on the timing of compelling strategic investment opportunities.

Available liquidity under our $725 million revolver was $682 million as of June 30. We have no significant maturities until January of 2021. Our debt capital structure is 62% fixed and 38% floating, with an advantageous blended interest rate of 5%. Given the flexibility under our revolver, our advantageous cost of borrowing and our efficient cash flow generation, we believe we have sufficient liquidity for current business needs, investing in our business, pursuing future growth opportunities and returning value to our shareholders.

Slide 6 shows our commitment to our dividend, which is a key way in which we return value to our shareholders. Our next quarterly dividend of $0.30 per share will be payable on September 1, 2017, to shareholders of record as of August 21, 2017. We've consistently paid a quarterly dividend, and our annual dividend of $1.20 per share is yielding approximately 5%, but represents only 25% of our free cash flow.

As we move into our seasonally busiest time of the year, we'll remain focused on driving further EBITDA enhancement and strong free cash flow generation by adding new business and continuing to focus on sustainable cost reductions and productivity improvements. This will help offset the impacts of top line pressures and reinforce Quad as the industry's high-quality, low-cost producer. Equally important, we will continue to focus on strengthening an already healthy balance sheet through ongoing debt reduction while also continuing to invest in our business to accelerate the Quad 3.0 transformation and return capital to our shareholders through our quarterly dividend, among other priorities.

And now I'd like to turn the call back to our operator, who will facilitate taking your questions. Operator?

(Operator Instructions) Our first question comes from Dan Jacome of Sidoti.

A couple of questions here. First, on the National Geographic contract, congrats. Just wondering, overall, what are their subscription trends with their customers on the printing material? I was just curious on that. That was my first one.

Specific to them, that's -- it's something I'm not sure they disclosed. But I'd say that generally speaking, when you look at publications, circulation is not the problem. Some people focus on newsstand, but typically, newsstand in this country is a very small part of their total reach. And the thing that always frustrates me when I look at the challenges they've had is the world's going through marketing disruption, is that their decline has been very slight on the circulation side for the most part. And so there's eyeballs there to look at advertising. And so I think that as the world kind of figures out the integration of the -- of where marketing dollars should be spent, I think it continues to be an opportunity. So again, advertising pages has been the publishers' challenge, not circulation.

Okay, that's helpful. And then wanted to turn over to -- well, just as you entered the second half, the back-to-school season, do you have any very high-level thoughts on how conversations are going with customer about what you expect for any page count trends? Are they going to, you think, fall in to that low single-digit decline this year? Do you have any color on that?

Well, obviously, we have a big mix of different product types. So I think that you've seen continued top line pressure, or at least page count pressure on the publication world due to the advertising trends. And they've continued to be double-digit decline, but again, the circulation has been holding up. When you look at retail, it's going to be a mixed bag because they're under a lot of pressure, and they've certainly been down as they've tried to really manage through disruption. But we see sort of different answers to that question. I've got one who has typically done lower page counts, or brought them down, who is now thinking about going back up. We've got a brand-new grocer coming into the country that is going with high page counts and high quality. So in terms of number of pages, that tends to ebb and flow. But I will say, it's -- we continue to see the overall circulation of retail insert has been under pressure. But I'd also say that as we go forward here, disruption is actually our friend. We are early on to disruption as a printer. And so we figured out a lot of things. So when we think about the stack we've created of services from not just execution with the print products we supply these people, but the 3.0 services that help them reduce costs, but also increase pace of being able to iterate content, and then start to be able to execute on where they spend their media dollars. I mean, everyone has to remember that the agency world is really in sort of disruption themselves these days as evidenced by people like Procter & Gamble, who are throwing down and saying that the lack of integrated measurement across channels doesn't work anymore and the lack of transparency of how all these channels drive each other doesn't work anymore. And so as people are trying to go through this, we're seeing the scaling of those 3.0 services happen. And I'm proud to say, and people always ask us, but those upstream services have now created over $100 million of incremental downstream revenue for Quad that would not have existed before. And so specifically, as we do things with like National Geographic or Cabela's, it's creating not just more print, it's also creating more revenue from all the different services we have, whether it's in-store signage to video. And so it's a long answer to your question, but I think the world knows that we're going to continue to see the top line pressures from our clients, but it's actually turning out to be a big revenue opportunity for Quad.

Right. And then -- well, that brings me to my last one. Just on content. I know you're working with customers across all the social media channels. And I'm not an expert in that arena. It just seems like there's so many out there, and they seem to be proliferating -- growing every day. Which do you think are the largest ones? You mentioned video. I was just curious if you had any thoughts on that. And then my last one was just a quick update on your co-mailing operations. I think we've seen kind of a little bit of consolidation in that space, nothing too large, but just curious. And that's it for me.

Yes. So on the first question there -- digital has become a very crowded space. And I do sit on an ad tech board that we've invested in with Pixability, which is a video-related ad tech company. There's about to be a big shakeout in ad tech, and it's already happening because of the lack of integration of all these offerings. And so as we see it, yes, certainly video is very strong. Search is very efficient. However, when you think about things like the traditional search, which really has driven a lot of the online quality of spend, we actually see a lot of overindexing now. So we see people way overspending in search and starting to see diminishing returns. So it doesn't mean you don't continue to focus on search or focus on video, it just means you need to focus on what the data tells you should be spending and not just be spending for the sake of it. And so I'd say that all these channels continue to stack on top of each other, but the big push in marketing today is how do we integrate the measurement back to making sure that if I'm the CMO of a marketer, I don't care what company you're in or whether it's print related or not, does the dollar of marketing spend create, say, $5 of revenue? Or does it create $10 of revenue? Because at the end of the day, that's all that matters. And then to your second part of the question, which really, I think, speaks to co-mailing, and it sounds like your question is a little bit related to consolidation in the industry, I think that this is a very large industry, and we've played one of the main roles in consolidation. I think you're going to continue to see consolidation happen because scale matters to our clients. And the reason it matters is just what you hit on, which is a big part of people who use print for marketing is distribution. And as we compete with all these other channels, because let's be clear, we are competing with other channels. Part of that top line pressure of the industry we're seeing has been revenue going to other channels. And so we are competing with a whole different set here. And for us, it's really important for the whole industry that we continue to focus on having enough scale or volume to be able to effectively penetrate the post office to get the biggest discounts for our clients, so that the ROI on print remains competitive.

Okay. And then maybe I'll just sneak in another one. Kind of your body language on the dividend was pretty interesting. You've been doing a good job paring down debt. Does it sound like you might be considering, potentially down the road, a higher dividend payout? Or am I jumping the gun here?

Well, look, I think that we look at a lot of things. And you scared me when you say you see my body language. I'm looking around (inaudible) right now. But I think that our uses of capital, we've been very consistent and very clear on. And we look at debt paydown as a primary, because we think that you need to always have dry powder and operate in this industry in a range that's sustainable. But that being said, we also look at opportunities to acquire like we did in packaging, like we've invested in both Pixability and Rise Interactive. But also, as we think about consolidating acquisitions, you got to be very disciplined about it. And so if we look at the use of capital being debt paydown, acquisitions or return to shareholders, right now, I think we want to focus on debt paydown, unless we have opportunities for acquisition. But you got to be very careful on how you stay disciplined in any of these uses of capital.

Yes. To Joel's point on that, I think we've been pretty consistent and disciplined in applying kind of our 4 criteria on the acquisition side. We always look at that strategic fit. But probably, the second and most important is, do the economics make sense? And when you look at, obviously, valuing the businesses that we see a lot of opportunities to come across our desk to value. Third thing is we want to integrate, but sometimes, these businesses we see, we just don't think we can successfully integrate those. Or in the case of a growth acquisition where it's not about integration, it's about does it moving -- does it move the needle on scale for our transformation? And then finally, does it stress our balance sheet? We've always tried to demonstrate. I think we've been pretty successful at demonstrating that. We will lever up for a deal, but we'll provide a clear pathway back to our long-term leverage range of 2x to 2.5x. And so when we think about the print industry, especially when it comes to consolidating acquisitions that will drive a lot of their value from removing costs and inefficient industry capacity, it's really important for us that we don't overpay and we don't stress our balance sheet. We've been pretty successful in maintaining this healthy balance sheet, and it let's just manage our business in a very disciplined manner, especially as Joel kind of give you the context of what's going on digitally, because we believe that's kind of our ultimate competitor is digital substitution. So really, in overpaying for a business, we spend a lot of time looking at potential acquisitions to make sure that the underlying earnings and the cash flows are high quality. And that's why we talk in our script about cash flow conversion. And when you look at the efficiency for every dollar of EBITDA, what that generates in cash flow, we want to make sure that there's a quality of earnings that supports the underlying assets that we would buy.

And so sort of kind of getting back to your question 2. We believe in a very sustainable dividend policy so that people can count on it. And so if there aren't other opportunities, we always weigh whether or not we'll do something in terms of returning cash to shareholders. But I think we've got a lot of priorities that are going to create value where we're spending that capital now. And so right now, with the 5% return, it's not a bad dividend that we're paying.

Yes, not -- I agree. And then on -- you brought up Rise. So I was just curious, are they working with all of your customers? Because I know when you bought them, they were small and I think Midwest-focused. I was just curious if you're being -- are you leveraging that team across...

They're Midwest located, but they're national, if not international. And so they've got a pretty large client list of the who's who in marketing. Yes, we're absolutely leveraging them. That's all part of the scalable integrated offering that we're giving people. And it truly is scaling. Again, we've created an annualized run rate of $100 million of downstream revenue between the efficiency services as well as the types of effectiveness conversations we're having with people.

Okay. That's interesting. Is it safe for me to assume that maybe you were able to use the Rise team or their kind of platform and secret sauce with the National Geographic contract expansion? Or is that maybe too...

Well, I'd rather -- I'd probably spend a lot of time with them trying to leverage them for someone like National Geographic or any of our clients to -- in their case, to actually sell -- I'd love to help them sell their online content, which is phenomenal. I mean, look at the series they're producing now that they're part of Fox, the company. I think that we can help them do that, just as we're helping other customers, retailers sell across channels to get people in stores or online. We've converted over 80 e-tailers to using print to drive traffic to their sites.

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

Well, thank you all for joining us. I just want to say that we're very pleased with this whole strategy that we've been onto with Quad 3.0, and it truly is scaling, as evidenced by the $100 million of incremental revenue we're creating. And we're at early innings. And so with that, I continue to look forward to sharing our story with you on into the future. Enjoy the rest of the summer. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.