Quad/Graphics Inc (QUAD) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Quad/Graphics Second Quarter 2018 Conference Call. (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 on last night's earnings release.

Alternatively, you can access the slide presentation on the Investors section of the Quad/Graphics' website under the Events and Recent Presentations link in the left-hand navigation bar. Following today's presentation, the conference will be open for questions. (Operator Instructions) Please also note, today's event is being recorded.

And at this time, I'd like to turn the conference over to Kyle Egan, Quad/Graphic's Director of Investor Relations and Assistant Treasurer. 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 a detailed discussion of our company's transformation to a marketing solutions provider. Dave will follow with a more detailed review of our second quarter 2018 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 Investor section of our website shortly after we conclude. The slide presentation will remain posted on Quad/Graphics' website for future reference.

I will now hand the call to Joel.

Thank you, Kyle, and good morning, everyone. I am pleased to report that our second quarter 2018 results were in line with our expectations. As our revenue performance reflects, we continue to make progress on our company's transformation in which we are leveraging our strong print foundation as part of a robust integrated marketing platform featuring a cohesive stack of services.

On Slide 4, we have included a visual representation of our integrated marketing platform. What makes our platform unique is that clients can use just one partner to plan, produce, deploy, manage and measure their marketing content across print, broadcast and digital channels. Through our integrated marketing platform, we reduced the complexities of working with multiple agencies and improved clients' process efficiencies and overall marketing spend effectiveness.

Our process begins with planning our clients' marketing strategies. First, we take the time to understand their marketing objectives so that we can build a compelling integrated media plan together. Our marketing strategy services include customer insights, analytics and media planning to help our clients better understand and connect with their customers. Our expertise in planning and media buying on behalf of our clients has grown to approximately $750 million and includes print, TV, radio and digital channels.

With a solid plan in place, we then help our clients produce the necessary creative assets such as photography, video, copywriting and design. Our creative operations include workflow optimization solutions and production management services and allow us to produce assets smarter and faster for our clients. At the end of the day, our job is to make their job easier, and our integrated marketing platform allows that to happen.

Once produced, we deploy those creative assets to the most appropriate media channels. We're focused on helping our clients reach their customers at the right time using the right channels to maximize engagement and ROI. To accomplish this, we measure performance throughout the entire process and make the necessary iterations along the way to drive the best results.

Lastly, we offer marketing management services that further alleviate clients' operational burden and reduce complexity by giving them the ability to potentially outsource all aspects of media procurement and production to Quad, depending on their wants and needs.

Recent wins validate that our Quad 3.0 strategy is working and delivering added value as represented in the following 3 client examples. One of our large national retail clients recently partnered with Quad for digital services, including page search, social, display placements, spend optimization and analytics reporting. These services are in addition to the traditional services we already provide, which include creative, production, media planning, printing and print distribution. Through Quad's integrated marketing platform, the national retailer reduces the complexity of using multiple agency partners, while improving process efficiencies and marketing spend effectiveness.

Another national retail brand recently partnered with us to help centralize their marketing services. We have configured an online portal will allow the retailer's 400-plus stores to browse and order consistently branded in-store signage, displays and other materials as well as manage procurement and production. With our help, the retailer is vastly simplifying its marketing operations.

And finally, Jockey International recently expanded its partnership with Quad to include photography services for its online retail, social and catalog channels as well as copywriting services. Quad's relationship with Jockey goes back many years, but until recently was primarily limited to print and prep work. We introduced the photo lighting solution that reduced the amount of retouching required resulting in quicker, more efficient and less costly photography production, while maintaining their high-quality standards.

We continue to be very pleased with our investment in Ivie & Associates and Rise Interactive. Both partners have strengthened our offering and the value we deliver to our clients. As leaders, Ivie and Rise regularly earn recognition for the work they do on behalf of their clients. For example, Ivie recently earned 12 Telly awards, the premier awards for excellence in video and television across all screens. Among its entries receiving recognition were television campaigns for Jewel-Osco and Methodist Health System.

In June, Rise made search marketing history with the first-ever perfect score for its entry in the 2008 Search Engine Land Awards. The awards recognize top performers in the SEO and SEM communities. Rise won Best Retail Search Marketing Initiative and was named Search Engine Marketing Agency of the Year in the large agency category. These awards confirm Rise's ability to drive business outcomes through innovative search strategies. Rise was also recently ranked on Crain's Chicago Business Fast 50 list. This is the third consecutive year Rise has appeared on the fastest-growing companies list. In fact, Rise is only 1 of 9 companies to make 3 or more consecutive appearances on the list. We congratulate both Ivie and Rise on all their accomplishments.

As we move forward, we are confident in our transformation strategy and the value it delivers to our clients and shareholders. To that end, we remain focused on our consistent strategy -- strategic priorities to continue to accelerate our Quad 3.0 transformation, drive further EBITDA enhancement through revenue generation and cost containment, generate sustainable strong free cash flow, strengthen the balance sheet and demonstrate our ongoing commitment to providing long-term shareholder returns through our consistent dividend and share repurchases such as the $37 million stock buyback we conducted in the quarter.

Before I hand the call over to Dave, I want to thank our employees who are making our transformation possible. We are fortunate to have a strong and engaged workforce that is committed to creating a better way, every day, for our clients and shareholders and our collective future. Thank you to all.

And with that, I will now turn the call over to Dave.

Thanks, Joel, and good morning, everyone. We're pleased to report that our financial results through the first half of 2018 were in line with our expectations, and we remain on track for delivering our 2018 financial guidance. As a reminder, the financial results from the Ivie and Rise investments are included in our financial results from the date of their respective acquisitions in the first quarter of 2018.

Slide 5 provides a snapshot of our 2018 second quarter and year-to-date financial results as compared to 2017. Net sales for the 3 months ended June 30 increased 5.4% to $1 billion, reflecting the impact of the Ivie and Rise investments as part as the company's continuing transformation to a marketing solutions provider. Organic sales declined 2.2% after excluding a 6.2% positive impact from those acquisitions and a 1.6% positive impact from increased pass-through paper sales. These were partially offset by a 0.2% negative impact from foreign exchange.

Net sales for the 6 months ended June 30 increased 1.1% to $2 billion, while organic sales declined 3.7%, after excluding a 4.1% positive impact from the Ivie and Rise acquisition and a 0.7% positive impact from increased pass-through paper sales. The quarter and year-to-date organic sales declines were due to ongoing print industry volume and pricing pressures and are in line with our 2018 annual sales guidance assumptions, which include continued downward price pressures of 1% to 1.5% and organic print volume decline of 1% to 4%. While we still expect organic decline in total print revenue for the year, we're pleased to see a 290 basis points or nearly 60% sequential improvement in the organic decline rate between our first and second quarters of 2018.

Adjusted EBITDA for the 3 months ended June 30 decreased $4 million to end the quarter at $90 million, as compared to $94 million in 2017, and our adjusted EBITDA margin declined to 8.8% compared to 9.7% in 2017. Adjusted EBITDA for the 6 months ended June 30 decreased $13 million to end the 6 months at $200 million of EBITDA as compared to $213 million in 2017, and our adjusted EBITDA margin declined to 10.1% versus 10.8% in 2017. Our team continues to focus on proactively matching our cost structures to the realities of the top line pressures we face in the printing industry, while still allowing for the company to invest in our transformation into a marketing solutions provider.

Free cash flow was $9 million in the second quarter and on a year-to-date basis was negative $13 million, and was in line with our expectations. This compares to $69 million in 2017. The year-over-year decrease was primarily due to expected timing differences from cash generated from working capital, which will be more weighted toward the end of our year and included an intentional increase in paper inventories during the second quarter in anticipation of increased paper cost and supply constraints during our seasonal peak in the third quarter. As a reminder, we realized our strongest volumes in the back half of the year due to seasonality. And as a result, our free cash flow will be primarily generated in the second half of the year.

Slide 6 provides a summary of our debt capital structure as of June 30. Debt increased by $83 million since year-end, to end the second quarter at $1.1 billion due to $71 million of net cash paid for the Ivie and Rise investments and $37 million of share repurchases that Joel mentioned we completed in the second quarter. We finished the second quarter of 2018 with a debt leverage ratio of 2.34x, well within our long-term targeted range of 2 to 2.5x.

Our debt capital structure is 60% fixed and 40% floating with an advantageous blended interest rate of 5.2%. We have no significant maturities until January of 2021, and available liquidity under our $725 million revolver was $585 million as of June 30. We believe we have sufficient liquidity for our current business needs, investing in our business, pursuing future growth opportunities and returning value to our shareholders.

Slide 7 shows our continued commitment to our dividend, which is one of the ways in which we return value to our shareholders. Our next quarterly dividend of $0.30 per share will be payable on September 7, 2018 to shareholders of record as of August 20, 2018. We've consistently paid a quarterly dividend and our annual dividend of $1.20 per share is yielding approximately 5%, but represents only 28% of our free cash flow at the midpoint of our guidance range.

Another way in which we return value to our shareholders is through share repurchases. As shown on Slide 8, we repurchased 1.9 million shares or $37 million at an average price of $19.59 per share during the second quarter under our $100 million share repurchase program. This represents approximately 4% of our outstanding shares. As stated on our previous call, the share repurchase goal was to offset dilution impact from 1 million shares granted during the first quarter of 2018 for a $22 million special retirement plan contributions to our employees as part of the benefit of tax reform and to help offset the cumulative impact of equity compensation grants made over time.

Through the end of the second quarter, $43 million remained to repurchase shares under our $100 million share repurchase program. As a result of the significant use of this program, our Board of Directors authorized the cancellation of the remainder of the program and authorized a new $100 million share repurchase program as an opportunity to provide sufficient capacity for us to repurchase shares into the future.

As we move into our seasonally busiest time of the year, we will remain focused on driving EBITDA enhancement and strong free cash flow generation by adding new business and continuing to focus on sustainable cost reduction and productivity improvement. We will continue to strengthen an already healthy balance sheet through ongoing debt reduction and invest in our business to accelerate our transformation to a marketing solutions provider.

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

(Operator Instructions) Our first question today comes from Jamie Clement from Buckingham Research.

Joel, Dave, I don't know if the numbers in front of me is minus 2.2% organic. Is that the best revenue quarter year-over-year you've had since you've been a public company?

Yes, it is. And I think that -- we are pleased to see that, of course.

Yes. And so some of the metrics Dave gave around anticipated volume and price, I think you said minus 1% to minus 4% on volume, minus 1% to 1.5% on price. Typically, I think you all speak in terms of minus 3% to 4% on volume, 1% to 2% on price. Is the better trend -- is this more a function of the account wins that you've kind of talked about over the last year or so, the expanded relationships that you've had with some of those preexisting customers, or are we at a point now where customers actually might be spending a little bit more?

Yes. Jamie, the guidance that we gave -- I've reiterated, again, here on pricing and print volumes, it's consistent with how we entered the year. We thought given some of the momentum we saw with existing accounts that instead of kind of a 3% to 4% volume decline range in print that we actually brought that to a 1% to 4% because we saw there could be some upside in the print volumes, which we did see in the second quarter. We are pleased with that. Second quarter does represent a long-term trend for us, and we're going to continue to work at this. But it's evident that the strategy that Joel's been talking about in transformation is working, and I think -- I'll hand it to Joel, but your answer shortly to what you were saying before, is it segment wins, is it continuing to sell more to existing customers? Yes, it's all the above. Joel?

Yes. And I think what you're seeing, too, is there's been a lot of disruption in the past couple of years in places like retail -- in marketing, in general. And I see -- you see a lot of people going through a lot of generations to figure it out. And I think they're starting to figure things out and realize that it truly is a multichannel world. And that multichannel doesn't just mean Facebook to Google, it also means all the traditional channels as well. And we're seeing that, especially in the receptiveness of our 3.0 conversations, which span both sides of the fence. And so to Dave's point, as we kind of have this continued transformation, I'm very pleased with the momentum that we're getting in terms of added services and products. And remember, I referred to our whole product offering as a stack because it's not just the ability to help people with digital, online, et cetera, but any of those conversations when we're talking about a full multichannel approach lead to revenue all the way down the stack, from media buying in digital all the way to printing retail inserts. And so I think the other thing that we're seeing is we continue to be pleased with the portfolio of types of clients we have. Typically, if you look through like retail inserts, it continue to be double-digit percent down as an industry. But we're single digits, so significantly better in the quarter than the industry, I think, due to the portfolio but also due to some recent significant segment wins. And then on the catalog side, the industry just shows in the quarter a little bit down, but we're significantly better at up almost 3%. And that's due to, I think, portfolio, but also more industry recent wins. Direct mail, I think, continues to be a good story out there, which we'll continue to grow as an industry. Publications, I think continues to lag with the challenge of ad pages being mid-teens negative, and we're actually low teens negative. And I think that has to do a little bit -- ours is a little bit more affected, so it might have been better. But there are some frequency changes in some of the titles we have where people, instead of doing 12 times a year might decide to do 10 times a year to manage that decline. And of course, books is a great story for the industry. It continues to grow and I think has good future. So I think you kind of -- if you look at all those things, not just the fact that people are kind of trying to stabilize through all the craziness of the environment and realized that you have to market in all channels to also us being very diligent on how we bring value added to our clients so that they want to bring more print to us and want to stay with us.

So Joel, just last question and I'll get back in the queue. But -- so post-Ivie acquisition, how has your go-to-market evolved in terms of taking traditional print customers and making more 3.0 customers? And then also I'm curious, like as you look at Ivie's customer base, how do you go-to-market and take 3.0 customers, for lack of a better phrase, and turn them into print customers.

Yes. Well, first of all, Ivie's customers were all print customers and...

Well, right. I mean, they may not have been your customers also.

Yes. Yes. I'll remind you that we've done business with them for a long time as the printer, but we had already been doing a lot of what Ivie did in terms of being in-house at people's businesses. They just go much broader within their businesses, which is why we are interested in them because we were going broader and it was just a natural fit. And it is not just Ivie, it's Rise as well. You have to -- in your question, you have to consider that, too. I mean, literally, within one of the examples of the big retailers here where we took on the digital spend, that was literally an Ivie customer that we have been printing for that then, right away, that we closed, enlisted Rise, Ivie enlisted Rise because there was a digital RFP possibility. And out of the blocks, we had a major win between those 2. And the fact that, that happening was so natural for both teams, all 3 teams understand that, just made it clearer that this is so natural in the direction we're going and the receptivity to the customer. I don't know that Ivie would have won that because they were probably more procuring digital from other vendors, who may not be as integrated, and suddenly now we've got all 3 of us at the table and making a major win. So it's happening quickly and again, this is fairly logical. I try and simplify this thing in that -- remember, our marketing customers, they all market but they're using so many different silos to buy where they market, too, to the point where there's not a lot of good measurement in the overall pool then. So when they spend $1 in marketing, they may be way overspending in search and underspending in retail insert or vice versa. There's times we tell people to do less print because the data says that. But overall, having these additional services and talents -- and by the way, Jamie, it's not just the 2 acquisitions. I already said that we're spending an additional $10 million in talent both internally and externally this year, which probably impacts our margin a little bit, but that's about building ahead. All that stuff is moving very quickly and ramping very quickly because this is very logical.

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

Just a quick question. Can you talk a little bit more about -- you said you wanted new retail brands contract maybe just some high-level thoughts what the conversations were before -- or around the RFP and then the eventual win for you guys? And it sounds like you said you're doing a back-end marketing analytics for them, but are you also doing some traditional printing and things of that nature?

I think you're crossing over between what we're just talking about with the retailer who bought digital and then segment wins that we have. So it's not like a singular client. But in that category, we continue to either pick up more talent or more -- share the spend that a customer might have and bringing in new customers. So it's a little bit -- I'd say that the retailers have been under pressure. So on the retail segment, it's really -- our offering has resonated the most. Again, because they're under pressure and they're using all channels, and they're still trying to drive traffic, right? You still have to drive traffic. I mean, you can look at -- there's a major Internet company out there that seems to dominate a lot of things. They have publicly launched a catalog so they could sell more toys. I mean, so I just think that you're seeing all these dynamics kind of come into play. And with the fact that our offering is about cutting costs by making them more efficient in how they create content and more importantly cutting the time frame it takes to create that content, combined with how do they deploy the content where they get a much better ROI to it because they're not overspending to the degree that they were in certain segments and underspending in others.

Okay. I mean, that helps, and then just one more. So it sounds like services component now, if my math is right, an encouraging 18% of revenue. And I don't know if you can comment on this, but do you guys internally or through board discussions have some sort of target for where that penetration ratio can go because, I mean, the 18% is definitely encouraging. I think it was like 14% just a couple of years ago. So I'm just trying to get some idea of where that trajectory might head because it would -- it could definitely help your multiple and other benefits.

Yes. You'll, obviously, see it continue to grow, and that's both organically and as we invest in new services and capabilities, that's absolutely true. But I think you also have to remember that, that tends also to create -- make the other products grow or at least decline less. Because as we have those conversations, like we said, we're spending a $750 million on media buying for our customers on 3.0, which includes print but also includes radio, TV, digital. And so I think that you'll continue to see that will grow the segment as a percent, but the decline will be managed because it's creating revenue all the way down the stack as well. And when we get to the print wins, those numbers are so much greater, the invoice size, than the sort of the services wins, which kind of will -- kind of balance it out. So I think you have to continue to think about it holistically. But I think, directionally, you're correct, it will continue to grow as a percent of the total offering.

Our next question is a follow-up from Jamie Clement from Buckingham Research.

Joel, I thank you, I'm glad you brought it up. So I was going to ask you about the report earlier this summer about Amazon starting to deploy catalog perhaps around the holiday season. I don't know if it's gone out yet, but I think the report said it was more going to be around the holiday season to maybe kind of fill the gap, fill Toys "R" Us' gap. What percentage roughly of your catalog business is originating from e-tailers that don't have brick-and-mortar? And I assume that number is growing.

I would say just about 100% because every market that we have, every retailer is, to a degree, an e-tailer. But I think what's encouraging is you see Internet pure plays, and I've talked about this in the past where we've converted in excess of 50-plus e-tailers to using print where they didn't use it before. But if you look at a catalog or whose -- by the way, most catalogs are retailers, to some degree, also, they're e-tailers. Retailers are e-tailers. So it's not something you can easily break out because, again, it's all mixed. But I think the encouraging thing is that people continue to advance the multichannel approach to include all channels. So while the company you mentioned is launching one, we're in talks with other retailers who bring in digital people to become their CMO, who's suddenly are saying maybe we should do a retail insert or a catalog. So I just -- I think that's that whole sort of the noise is starting to get washed out and people are realizing that the marketing of the future is all channels together in one cohesive stack that's integrated so that you can measure it accurately and then decide what to do next because it's an ongoing circle, if you look at our slide, that it doesn't stop. You don't just plan a whole event and then measure it and say, "Wow, that was great". You use the measurement to plan the next one and on, and on, and on. Does that makes sense?

Yes. It absolutely does. It absolutely does. Dave, if I could ask just one follow-up to you. How should we -- if we look at your inventory line item, how much of this -- should we be thinking about it versus December 31? Or should I be thinking about it versus March 31 in terms of how much of that increase in inventory is paper. Is it like all of it?

No. The impact that we had, as you know, with paper prices have been increasing based on tariffs that have been placed on paper. So there's a natural increase in inventory levels because of pricing, but also we purposely bought ahead anticipating...

Yes. That's what I was going to ask you about. The latter portion of it like, approximately, how much of that -- and I don't know if I should be looking at June over December or June over March?

You look at June to June, actually, between year. $15 million of our increase is related to buying ahead on inventory and the increased price impact of paper.

Yes. Jamie, I think -- go ahead.

No. I would say, Dave, your answer was a lot clearer than my question.

Well, Jamie, I'd also add to it though, a bunch of that is about the newsprint tax that the Commerce Department put dumping taxes on some of the Canadian mills. And it's something I, personally, aggressively been working on for months now. In fact, I hosted Senator Schumer up in our Saratoga plant who, early on, did an op-ed really talking about the damages it's doing to the newspapers in the Northeast. And he wanted to come see our plant because it's in his neighborhood and really talk to the issue, and then since then he met with Wilbur Ross. And then, a week ago, I got a call from Paul Ryan who we've been working with, who's been very effective as well. Paul then informed me that Wilbur Ross wanted me to come to Washington to talk directly about it. So I went to there just this Monday and had, I think, a productive conversation. We'll know where that goes tomorrow because today is the legal date by which the Commerce Department needs to do their final recommendation to the international trade group that then rules on it, and so they'll come out with it tomorrow. And then the ITC has to then make their final decision on the fairness of the tariff around, I think, August 28. But we've also worked with the ITC. We've got quite a few senators and congressmen and industry players who have testified there, we've testified, to build the picture that if Commerce decide to keep going with this tariff, we've got a lot of work we did on the side, who has to rule on it. And so if they decide to pull it back, pull it back to a degree, that will be the number that the ITC will have to rule on in August. So I'd say that the conversation felt very productive. There's a lot of logical reasons why this is different than all the other tariffs stuff they're dealing with because if you look at newsprint demand in United States, there's 3 million tons worth of demand and only 1 million tons of production capability. And those million tons are only in certain regions. So it's a pretty logical story, so again -- but I think it's a long-winded way of answering your inventory question that it made sense for everyone to kind of load up ahead of the tariff going in because it's a 20-plus percent increase.

Yes. I think -- and Joel, after you -- now that you brought it up, I did -- I noticed some news stories on that, and I think there may be a bit of an inaccuracy in some of those news stories. I wanted to make sure I'm right. Some of the news stories said that, theoretically, $90 million of cost could be -- increased cost could be absorbed by Quad/Graphics. That really should say $90 million, theoretically, would be absorbed by Quad's customers, right?

Customers, yes. Paper is...

And then, obviously, the risk is if they can pull back, right?

A very important distinction. Papers are pass-through that we do for our customers. And that $90 million is significant because, first of all, the newspapers get hurt through circulation. The retail inserts gets hurt through circulation going down because that's the carrier and also the cost. So I think we've laid out a very good road map for Commerce to have a favorable outcome here, but time will tell. In fact, 24 hours from now we'll tell. And Washington is a little bit different place these days with predictability, but I feel very good about the conversation we had.

At this time, I'm showing no additional questions.

Okay. Well, thank you, all, for joining us. We're very pleased with our trajectory. We're very pleased with the view out of our front window in terms of the long-term transformation that Quad's been going through, and we'll talk to you next quarter. Thank you.

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