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Edited Transcript of QUAD earnings conference call or presentation 3-May-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Quad/Graphics Inc Earnings Call

SUSSEX May 5, 2017 (Thomson StreetEvents) -- Edited Transcript of Quad/Graphics Inc earnings conference call or presentation Wednesday, May 3, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David J. Honan

Quad/Graphics, Inc. - CFO and EVP

* J. Joel Quadracci

Quad/Graphics, Inc. - Chairman, CEO and President

* Kyle Egan

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Conference Call Participants

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* Daniel Andres Jacome

Sidoti & Company, LLC - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Quad/Graphics First 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 earnings 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. (Operator Instructions) Please also note that today's event is being recorded. I'd like to turn the conference call over to Kyle Egan, Quad/Graphics' Manager of Treasury and Investor Relations. Kyle, please go ahead.

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Kyle Egan, [2]

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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 path forward in 2017. Dave will follow with a more detailed review of our first 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. The slide presentation will remain posted on Quad/Graphics' website for future reference.

I will now hand the call over to Joel.

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [3]

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Thank you, Kyle, and good morning, everyone. I am pleased to report that our first quarter 2017 results were in line with our expectations. Adjusted EBITDA and adjusted EBITDA margin both increased compared to the same period in 2016. In addition, due to our ongoing focus to reduce debt, our debt leverage ratio improved from last quarter.

On our path forward, we are focused on 5 key priorities, which are to generate strong free cash flow to support value-creating opportunities that are a part of our continuing transformation; drive further EBITDA enhancement through ongoing sustainable cost reductions and productivity improvements, while remaining focused on incremental revenue; strengthen the balance sheet through debt and pension liability reductions, with a focus on improving our debt leverage ratio; demonstrate our ongoing commitment to provide long-term shareholder returns through our annual dividend of $1.20 per share; and continue to strategically invest in our Chapter 3 transformation, while strengthening our core platform.

Our Chapter 3 transformation follows what we have done over the last 46 years, which is listen to our clients' needs, invest where necessary, and transform to further expand our value creation. Our transformation is ongoing and evolving, and built on the simple premise to create a better way, every day. Today, our transformation coincides with the seismic shift going on in marketing right now as marketers and publishers try to create more content for more channels with the same or fewer resources at a faster pace, orchestrate activities across the right mix of media channels to break through the noise, increase response and loyalty and activate the right message by the right media at the right time.

The outlook for trade on Slide 3 of today's presentation is a visual representation of how Quad is helping our clients. We are focused on developing products and services that skillfully weave together multiple online channels with offline channels to work in unison and produce better results for our clients. The cyan, magenta, yellow, and black strands, or CMYK, represent our strong foundation in print. The red, green, blue strands represent the RGB electronic color model. Together, these channels represent our continued evolution as a marketing services provider. Data, the one seen, is woven throughout and is the driver that enables our clients to deliver individualized messaging at the right time through the best mix of channels.

As we continue along our journey to redefine our company in today's multi-channel world, from a printer who just produces high-quality products to also a marketing service provider, we will create value in 2 distinct ways. First, we will help our clients market more efficiently and effectively using our strong print foundation in combination with other media channels. Creating efficiencies with regard to content creation has always been a part of our offering. By tapping our expertise in CI, or continuous improvement, which includes lean enterprise and process engineering, we help our clients manage their content work streams, and for some, we do this is on-site at their location. We also use our expertise to help clients improve the effectiveness of the marketing spend by helping them coordinate the strengths of different channels. Our goal is to better inform and measure clients' marketing decisions across all channels and allow clients to iterate that process much faster.

Second, with an engaged workforce, we will continue to invest and strengthen our core manufacturing platform to ensure it remains the strongest and most sustainable in the industry. In addition, we will continue to aggressively manage cost and improve productivity to hold the line on adjusted EBITDA margins. This supports our goal being the industry's high-quality, low-cost producer, while generating strong free cash flow to support value-creating opportunities as we transform over time.

Before I hand the call over to Dave, I would like to extend my sincere thanks to our employees for their ongoing dedication, determination and hard work as we maintain our strong culture while we evolve from a critical commodity vendor to a trusted marketing partner. They play an important role in Quad/Graphics' transformation and make it possible for us to create a better way, every day.

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

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David J. Honan, Quad/Graphics, Inc. - CFO and EVP [4]

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Thanks, Joel, and good morning, everyone. We delivered first quarter results in line with our expectations, and we remain on track to delivering our 2017 financial guidance.

Slide 4 provides a snapshot of our 2017 first quarter financial results as compared to 2016. Net sales of $1 billion were down 4.2% from 2016. Organic sales, which exclude pass-through paper sales and foreign exchange impacts, declined 2.8% due to ongoing industry volume and pricing pressures. Pass-through paper sales declined 1.2% and foreign exchange losses negatively impacted sales by 0.2%. The organic sales decline of 2.8% is in line with our annual sales guidance assumptions, which anticipate a volume decline of 1% to 4% and a price decline of 1% to 1.5%.

Adjusted EBITDA increased $2 million in the quarter to end the quarter at $122 million as compared to $120 million in 2016, and our adjusted EBITDA margin increased 70 basis points to 12.2% compared to 11.5%. The increase in adjusted EBITDA, despite lower net sales, was driven by lower cost of sales and SG&A, and included a $5 million net year-over-year nonrecurring benefit from a $15 million reduction in our vacation accrual, partially offset by a $10 million onetime benefit we recognized in 2016 from the collection of a vendor receivable that was previously written off.

The company generated $40 million of free cash flow in the first quarter compared to $86 million in 2016, representing a $46 million decrease between years. This decrease was primarily driven by an expected reduction in the benefit from our controllable working capital improvement program. We generated $36 million in cash flow in the first quarter of 2017 from this program, as compared to $63 million in 2016. Our controllable working capital improvement program has generated well over $200 million in sustainable improvements in free cash flow to date, and still has more room to go, as evidenced by the $36 million in sustainable reductions recognized this quarter. Our overall free cash flow results in the first quarter are consistent with our annual free cash flow guidance of $225 million to $275 million.

Slide 5 includes a summary of our debt capital structure as of March 31. We continue to remain focused on strengthening our balance sheet through debt reduction. Since December 31 of 2015, we've reduced debt by approximately $250 million and finished the first quarter with $1.1 billion in debt and capital lease obligations. Our first quarter free cash flow drove $28 million in further debt reduction and resulted in improving the debt leverage ratio to 2.29x. We continue our focus on debt and pension reduction as a primary use of cash and believe that operating within our consistent leverage range policy of 2 to 2.5x over the long term 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 $685 million as of March 31. We have no significant maturities until January of 2021, and our overall blended interest rate is 5%. Our balance of fixed-to-floating rate debt shifted more towards fixed rate debt in the quarter, following a 5-year, $250 million interest rate swap we entered into. Our debt capital structure is now 62% fixed and 38% floating. Given the flexibility under our revolver, our advantageous cost of borrowing and our free cash flow generation, we believe we have sufficient liquidity for current business needs, 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 June 2, 2017 to shareholders of record as of May 22, 2017. We have consistently paid a quarterly dividend and our annual dividend of $1.20 per share is yielding approximately 4.5% but represents only 25% of our free cash flow.

While much of the year still remains in front of us and our revenue is weighted more towards the seasonal back half of this year, we're pleased that our first quarter results were in line with our expectations and that we remain on track for delivering our 2017 financial guidance. As we move forward in this challenging industry, we'll remain focused on driving further EBITDA enhancement and strong free cash flow generation by adding new business and continuing the focus on cost reductions and productivity improvements. Strong earnings and cash flow will allow us to strengthen an already healthy balance sheet through ongoing debt reduction, while also continuing to invest in our business to accelerate the transformation of our go-to-market strategy 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'll facilitate taking your questions. Jaime?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from Dan Jacome from Sidoti.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [2]

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Great, appreciate the time. Had a couple quick questions here. Wanted to just start with postal cost, just wondered if you have an update on the rates overall, but keep it -- more generally, what's the tone, overall, with your customers and they're feeling about postal rates and just other related distribution costs right now?

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [3]

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Yes, I think we've -- I think our customers are in a fairly good place right now because of some of the changes that happened last year. But I think the big deal is the postal bill that we've all been working on for a number of years, that has been in pretty good shape with a lot of agreement from a lot of the constituents on what can really create a lot of relief for the post office. And creating that relief is really important, things like preretirement funding of health care and some of the things that you wouldn't have to do normally in a business, really speaks to what they can do on pricing on a go-forward. I think the challenge right now is that in the House, you have -- Chairman Chaffetz just announced that he is no longer going to say in government or at least not in federal government, and he was really sort of on guard and leading the charge on the House side. So there's going to be a little bit of sort of wait-and-see in terms of how the void is filled, but having unions as well as different customer constituents are generally aligned with what the bill looks like is very important. And obviously, as we know, there's a lot going on in Washington, so sometimes it's hard to push things forward, but we stay on it. In fact, we have people there this week working the Hill to try and continue to push it forward. So I think we're in fairly good shape for the time being in terms of stability in postal rates, but I think a lot needs to come as we sort of keep pushing forward with postal reform.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [4]

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Right, yes. No, everything I read shows Quad/Graphics is heavily involved in the conversation, so that's why I was asking. Just wanted to turn it over to the digital print supercenter you guys started in December, I think it's in New Jersey. Just remind us again how is that going? Did you get all the digital presses up to the kind of operational level you wanted? And then, longer term, what do you think it's going to do for the business?

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [5]

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Well, I mean that's actually just one part of the whole digital strategy. It's actually going quite well, and we've done some consolidation that really kind of works towards that goal. But the digital platform is actually quite robust here at Quad from out in Westhampton and sort of the East Coast, but also Versailles, Kentucky, up here in Wisconsin, we literally have a lot of equipment at play. And it depends on the product line that you're talking about. So in book publishing, it's a big deal. With the new work we've taken on from Cengage and how we're executing for them, it's about getting rid of inventory for them on the book side, which is what the book industry needs to do, where you're using digital print operations to really kind of lower the back size, so they don't have to take these big events on inventory. From a direct mail standpoint, throughout our platform, it really is about getting to one-to-one marketing. And as we sort of see the online channels and offline channels converge, you're really talking about a lot of the trigger-based marketing where you are truly speaking to the individual, with images actually changing on the fly. But it's also about the combination of what's the right technology at the right time. I mean, sometimes a digital print press will make sense because of the variability; sometimes, it won't. And many times, there'll be a hybrid of it, which we do on a lot of our direct mail now, where you have a traditional printing press, combined with a digital press to give the best of both worlds based on the economics. So it's all ROI-based, but clearly, the world of variability and personalization is here, and it's been here for a long time, printers have been doing it for close to 30 years. But as Dot Com 2.0 continues to mature and as marketing continues to realize that the pendulum needs to swing a little bit back to the center of the world, not being completely only digital, but digital and physical, you'll continue to see, I think, that technology take off. And it's really based on the ROI on your marketing spend. We know that personalization drives a higher ROI through higher response rate, whether that's online, offline or mobile. And so it's going very well, in short, and we'll continue to keep investing heavily in the space.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [6]

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Excellent. And then just one quick last one, and then I'll get in the queue. Just stinking forward to the second half, I know, seasonally, it's usually better for you guys. Can you give us a little flavor for maybe the tone for advertising budgets on customers, page counts, anything you can give us? Is it kind of steady as she goes or have you seen anything, maybe in the first half of the year, that is helping you think about what the second half might have for us? I know it's only May, but [it is coming through].

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [7]

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Well, for first quarter, second quarter is the seasonally low part of the year. First quarter, I think we saw a lot of sort of reactionary things happening based on fourth quarter, but also, there's a lot of reaction going on in the world in the first quarter to all the events surrounding us. But there's continued pressure, especially on the retail space. But I really look at that as opportunity because we're engaged in a very different level of conversation with a lot of retailers because we're looking at how we can continue to offset some of the challenges they've had. And I think it's easy for people to say that retail is being disrupted, and that's what causing everything. But I would just add a word of caution that there's 2 things going on. There's certainly disruption, but there's also the fact that this country is so over-stored in retail markets. And so you saw 3,200 stores close in the first quarter, but you saw 2,500 other new stores open. And if you really compare the retail space in the United States from a brick-and-mortar standpoint, as a per capita basis in terms of square feet, there's 5x more square feet per capita than the rest of the developed world. So you're seeing 2 things. You're seeing a reset on the size of the footprint, but then you're also seeing disruption, which is going to lead to a reset on the model. And those who go fast and those who realize that it's about urgency and it's about a new model and it's about adjusting quickly, they're going to win. And the ones who can't or won't will disappear. And so with that, I think the retail space is where we've seen a lot of pressure, but again, it's early in the year, and we really -- the second half is when everything happens. So we don't read too much into the current pressures there as well as on the advertising page front with publishers. There's some noise going on with potential combinations and consolidations, but ultimately, the same holds true. Those who move fast and adjust their model and invest in quality content are going to win, and those titles and those things that haven't are going to cease to exist. And so it's going to be an ever-evolving world, but we planned for this, and we've been very straightforward with this all along that we expect continued downward pressure in the industry. However, we see that as a real opportunity as we expand our offering to sell more to the clients we have and gain more clients because of that broadening offering. Does that make sense?

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [8]

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Yes, absolutely. I mean, we just keep hearing about the world coming to an end on that retail landscape, but what you're basically saying is that the optics can be a little bit (inaudible) this is already baked into your strategic plans.

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [9]

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Yes, I mean, it reminds me of 2011 when Borders went out of business in the book world, and it was at the same time, obviously, that the Kindle was going crazy and the Kindle Fire was about to come up. Everyone attributed a huge volume drop to the Kindle, when in fact, it had a lot to do with a disruption of inventory because of the order dislocation that all that inventory had to go somewhere and there was disruption going on. But if you watched what happened in the book world today, the pendulum swung back and actually, books are up, printed books are up and digital is significantly down. And so I think people have to be careful. If -- everyone is being disrupted today, and it's very easy to say that, well, that means everyone is going to die. Well, that's not what is going to happen. It's going to be, there are going to be winners and losers, and I think as a partner to our clients, the more that we can develop our offering that helps them with that ROI marketing spend and implement it faster and get them to implement it faster, the sense of urgency is huge because disruption keeps speeding up. And again, that pace at which winners win is increasing and the pace at which losers lose is increasing as well.

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Daniel Andres Jacome, Sidoti & Company, LLC - Research Analyst [10]

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Right. Yes, they need you more now than ever, probably, so.

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [11]

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And when people are in that space, they're more willing to listen to try things, and you're seeing disruption in terms of who they get advice from, like the big agency group. You're seeing Procter & Gamble and Unilever throw down on the traditional measurement model versus digital. They want more transparency and they want ROI because they're seeing the ROI go down. And a lot of them are realizing that, okay, we're out of whack and the measurement's wrong, and we have to get back to a connected measurement that's completely integrated across all channels. Because all they care about ultimately in marketing is when I spend $1 on marketing spend, does it create $5 of revenue or $10 of revenue. And I think too often, people can look at the shiny new object and just start spending on it regardless of measurement, and digital was the Wild West. And now it's coming back to reality where the measurement has to backup the technology.

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Operator [12]

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(Operator Instructions) And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

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J. Joel Quadracci, Quad/Graphics, Inc. - Chairman, CEO and President [13]

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Great. Thank you, operator. Well, we're pleased with the good start to the year. Again, first quarter doesn't make or break a year, but I think that it shows that we continue to manage at a very aggressive pace, but also feel very good about the model that we're creating, really, to help everybody in our client base in this sort of ever-changing world that continues to speed up. So we look forward in the next several quarters to continue to update you on our progress. Thank you for joining us.

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Operator [14]

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And ladies and gentlemen, at this time, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your line.