Quad/Graphics, Inc. Q2 FY2021 Earnings Call

Good morning, and welcome to the Quad's Second Quarter 2021 Earnings Conference Call for Analysts and Investors. I would now like to turn the conference over to the Quad management team. Please go ahead.

Thank you, operator, and good morning, everyone. With me today are Joel Quadracci, Quad's Chairman, President and Chief Executive Officer; and Dave Honan, Quad's Executive Vice President and Chief Financial Officer. Joel will lead off today's call with a business update, and Dave will follow with a summary of Quad's second quarter and year-to-date 2021 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. Quad's 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. Finally, a replay of the call and the slide presentation will be available on the Investors section of quad.com shortly after our call concludes today. I will now hand over the call to Joel.

Thank you, Katie, and good morning. We are very pleased with our second quarter operating and financial performance, which exceeded our expectations. Net sales increased 19%, driven by higher print, logistics, and agency solution sales, which rebounded compared to the pandemic period in Q2 of 2020. Our services offerings alone were up 33% in the quarter and 15% year-to-date. These positive trends, which included organic growth as well as print segment share gains from new clients, reflect our employees' hard work and agility, the strength of our business strategy, and the success our integrated marketing offering is having in the marketplace. Thanks to the strong performance and higher cash flows, we were able to significantly reduce net debt by approximately 25% over the past 12 months. We will continue to focus on maintaining a healthy balance sheet while simultaneously making strategic investments in talent, technology, products, and services to accelerate our position as a marketing solutions partner. On Slide 3, we highlight key competitive advantages that distinguish Quad as a leading marketing solutions partner and create more value for our clients. These advantages reflect our commitment to innovation, integrated marketing platform excellence, and culture and social purpose. I will spend some time today discussing these advantages, starting with how we are driving innovation and growth through new talent we're bringing on board. Turning to Slide 4. In July, we welcomed Josh Golden, former President and Publisher of Ad Age, as our Chief Marketing Officer. Josh has incredible insight into what is important and relevant to marketers and is an advocate for an uncomplicated approach to addressing those challenges. The energy and expertise he brings to Quad is key to highlighting our singular place in the market, where we offer through-the-line marketing solutions with the ease of engagement of a specialized agency. Josh will work closely with me, Eric Ashworth, our Executive Vice President of Product and Market Strategy and President of Agency Solutions; and Julie Currie, our Chief Revenue Officer, to accelerate our visibility and drive growth across our entire solutions portfolio. This includes continuing to position Quad as a strategic industry partner with deep expertise in helping brands and marketers create big ideas, along with reducing complexity, increasing efficiency, and improving marketing spend effectiveness. We are excited about the future with Josh as part of our team. Turning to Slide 5. We continue to invest in our long-term growth platform, which includes MarTech solutions that help clients optimize their marketing efforts. Rise Interactive, our tech-enabled performance marketing agency, just won Product of the Year for its innovative platform Connect at the prestigious sales and marketing awards. Connect is a cross-channel media optimization platform that helps marketers know where to allocate their digital marketing budget to achieve their business goals. This type of MarTech solution has become increasingly important as the number of marketing channels expands, each with its own ROI measurement, leaving brands with siloed technology and without a solution that informs where to spend the next dollar based on which investments are driving performance. With the sheer volume of data, marketers need to know which opportunities to focus on and be able to take immediate action. Connect brings cross-channel media management to life at scale with performance transparency unavailable anywhere else. This innovation eliminates the noise of disparate data sets and helps marketers identify the specific value-driving actions they need to take in real-time to drive revenue and grow their business. As an example of the power of this platform, Rise recently helped a national retail chain secure more co-op budget from its brand partners by identifying real-time opportunities to capitalize on strong sales performance. By focusing digital ad spend on times when demand for particular brands and their products are performing well, we help the retailer drive incremental sales while also positioning it as a proactive partner. This was a win, win, win. Brands won by getting proactively notified when their products were selling well, information that was historically more challenging to obtain from the retail partners; the retailer won because it could do more advertising with co-op dollars; and we won by demonstrating our value as a true partner for integrated marketing solutions. Turning to Slide 6. The retail and e-commerce spaces have evolved dramatically in recent years, exposing significant workflow challenges for marketers. Additionally, the pandemic and work-from-home requirements have forever shifted how marketing teams collaborate daily. In light of these disruptions, clients are increasingly demanding a more automated approach to managing their marketing efforts. This is where Quad's client technology team excels. Our team of software developers and UX experts help our clients optimize their processes with highly configurable and scalable workflow solutions designed to address their unique challenges. Currently, more than 200 clients leverage our technology with more than 150,000 users. Our client technology experts are presently helping a leading global retail and e-commerce company optimize and deploy highly regionalized advertising and in-store promotional signage as it expands its grocery footprint over the next year. We deployed our content management workflow solution to centralize and organize all this client's in-store marketing efforts and simplify regional complexity. Our team is also assisting with business process implementation and change management. As a result of our integrated solution, the client is transitioning its in-store signage production to our platform. We also introduced this client to our analytics solutions to dynamically track the effectiveness of each campaign. It is through these types of innovations that we are able to extend and grow client relationships beyond limited engagements and create additional revenue for our clients and our company. We also continue to strengthen our commitment to platform excellence to align with our holistic strategy as a marketing solutions program. At the end of June, we divested our 3PL brokered freight business, QuadExpress, for a total consideration of $40 million to the Mullen Group, a leading Canadian logistics provider. This divestiture, which represented a small portion of our global logistics business, supports our established strategy to optimize our product and service portfolio and invest in those parts of our business that accelerate our position as a marketing solutions partner and create more value for our clients and other stakeholders. We are pleased to have found a great home for the QuadExpress team. Given recent nationwide labor shortages, combined with increased volumes at our print manufacturing facilities, we have intensified our focus on attracting and retaining employees through a holistic approach designed to ensure we have the talent needed to support our platform and growth objectives. While I continue to be concerned about labor shortages, I'm pleased with the traction we are getting with our recent hiring efforts, especially as we continue to ramp up for the historically busier back half of the year. These hiring initiatives complement robust retention efforts that include our accelerated career training program and the expansion of Quad's business resource groups, which connect employees with shared backgrounds, interests, and issues, creating a more inclusive environment. We continue to be a strong, dependable employer and are well-regarded in the industry and among our clients for our operating stability, reliability, and agile performance. Turning to Slide 7. Through our commitment to innovation and platform excellence, we continue to attract new clients from existing verticals while simultaneously growing our presence in critical expansion categories like technology, consumer packaged goods, and direct-to-consumer. These brands, admired for their excellence and the loyalty they have built with their customers, have placed their trust in us to help solve their most urgent marketing challenges. As the ad market and broader economy continue to recover and return to growth, we will continue to focus on attracting new clients as well as growing share through our expanded marketing services offering. On Slide 8, we address our commitment to culture and social purpose, a commitment that goes back to our company's founding 50 years ago. Our strong culture and values include an enduring focus on environmental, social, and governance matters. For example, in the social space, we are building a more comprehensive and sustainable DEI strategy, which not only benefits our employees but also our industry and the communities we call home. When it comes to the environment, we have always sought to minimize the impacts of our business operations by conserving raw materials, minimizing waste, and recycling and reusing whenever possible. In 2020, we recycled nearly 300,000 tons of paper, along with 3,000 tons of metals and 500 tons of plastics. Currently, we recycle 98% of all material byproducts from our manufacturing processes and have multiple initiatives in place to increase that amount to 99.5%. We take our role in creating a better way seriously through our social, environmental, and economic contributions. Before I turn the call over to Dave, I want to thank our employees for their continued hard work and dedication and congratulate them on our 50-year milestone anniversary, which we marked on July 13. The team has been resilient in the face of a truly dynamic environment and unprecedented challenges, and I thank them for supporting each other and managing through disruption in its many forms to continue to serve our clients well. I'm proud of how we have navigated the pandemic, and with ad spending in the wider economy now recovering, we are focused on growth. As always, we will remain nimble so that we can adapt to changes in the demand landscape. With that, I'll now turn the call over to Dave.

Thanks, Joel, and good morning, everyone. Slide 9 provides a snapshot of our second quarter financial results. As Joel mentioned, we delivered strong operational and financial results that exceeded our expectations for the quarter. Our business is clearly building momentum, and our clients are growing more confident in their own recoveries. As a result, we are raising and expanding our financial outlook for 2021 net sales, adjusted EBITDA, and debt leverage. Net sales were $694 million in the second quarter, an increase of 19% from 2020, significantly better than our previous outlook for the quarter of 10% to 13% net sales growth. Net sales increased by $109 million year-over-year, which included gains across all of our businesses: print, logistics, and agency solutions, which rebounded compared to the pandemic-impacted second quarter of 2020, as well as print segment share gains from new clients. As importantly, we converted the net sales growth into strong free cash flow. In combination with proceeds from asset sales, we reduced net debt by $120 million in the first 6 months of 2021. Our focus on our balance sheet has resulted in approximately a 25% reduction in net debt over the past 12 months despite challenging business conditions. On a year-to-date basis, net sales were $1.4 billion, down 1% as compared to 2020, primarily due to the impact from the COVID-19 pandemic in the first quarter, which represented the final quarter of annualizing the pandemic impact on our net sales. The net sales growth in the second quarter of 2021 nearly offset the first quarter's net sales decline due to strong rebounding growth in print, logistics, and agency solutions sales and new client wins. Adjusted EBITDA was $60 million in the second quarter, flat with 2020, primarily due to higher earnings from the 19% net sales increase, offset by nonrecurring benefits in 2020, primarily related to approximately $30 million in temporary cost reductions implemented in response to the pandemic's abrupt impact on our net sales. Adjusted EBITDA margin was 8.6% in the second quarter as compared to 10.2% in 2020. This was in line with our expectations as we noted during our first quarter earnings call that second quarter margins would be somewhat pressured due to the nonrecurring nature of the temporary cost savings measures implemented in the second quarter of last year, which included initiating furloughs, temporary wage reductions, hiring freezes, and temporarily suspending production at several of our manufacturing facilities. We've worked diligently over the past year to convert a majority of these temporary cost savings into permanent savings. However, some of these temporary cost savings were subsequently reinstated in the back half of 2020 to support the recovery in net sales from the pandemic's peak impact during the second quarter of 2020. The year-to-date adjusted EBITDA for the 6 months ended June 30, 2021, was $126 million, a $9 million or 7% decrease as compared to $135 million in 2020. Adjusted EBITDA margin was 9% in 2021 as compared to 9.6% in 2020. The strong second quarter net sales growth and related adjusted EBITDA impact partially offset the full-year impact of nonrecurring benefits in 2020, primarily related to approximately $30 million in temporary cost reductions and a $12 million benefit in 2020 from a change in vacation policy. Free cash flow was $62 million in the first half of 2021, an increase of $33 million versus the same period in 2020, primarily due to higher net cash provided by operating activities driven by working capital improvements and lower restructuring costs along with an $11 million decrease in capital expenditures. Slide 10 includes a summary of our debt capital structure as of June 30th. We've reduced net debt by $120 million since the end of 2020. Over the past 12 months, we've reduced net debt by $225 million or nearly 25%. This is the outcome of our continued disciplined approach to managing our balance sheet to allow for stability during uncertain times, as well as to provide more capital allocation flexibility to take advantage of opportunities. During the past year, we divested 2 of our business units: our book printing business in 2020, and our QuadExpress 3PL brokered freight business in this past quarter. These divestitures are part of our established strategy to optimize our product and service portfolio and invest in those parts of the business that accelerate our position as a marketing solutions partner and create more value for our clients and other stakeholders. The QuadExpress 3PL logistics business had approximately $135 million in revenue and represents a small part of our global logistics product offering and was sold for $40 million, representing an attractive price with a multiple of over 8x adjusted EBITDA. In addition, during the second quarter, we also completed a sale and leaseback of our Chalfont, Pennsylvania production facility for $20 million. Over the past 12 months, we've realized approximately $100 million in proceeds from asset sales and generated $160 million of trailing 12-month free cash flow from our business operations. The result was $260 million of cash to allow more focus on transformational strategy, better capital allocation, and further debt reduction. Our debt leverage improved to 3.0x compared to 3.35x at the end of 2020. While this leverage ratio is above our long-term targeted leverage range of 2x to 2.5x, we will continue to significantly reduce debt during 2021. We expect to further improve our debt leverage ratio to approximately 2.75x by the end of 2021. As of June 30th, our blended interest rate was 4.9%, and we maintained our strong liquidity position with up to $463 million of availability under our revolving credit agreement and $98 million of cash on hand. Quad's nearest debt maturity is our 7% senior unsecured notes due May of 2022, which has $239 million outstanding. Regarding the senior unsecured notes' upcoming maturity, we believe we are well-positioned to address the notes at or before their maturity in 2022 with our ample liquidity. As we review our financial outlook for 2021 on Slide 11, we remain optimistic and confident. We have strong sales momentum heading into the second half of the year, and we are increasing our full-year net sales outlook for organic growth of 1% to 3% in 2021, which excludes the impact of our June 30th QuadExpress divestiture for the back half of the year. In addition, we expect full-year adjusted EBITDA to be in the range of $240 million to $260 million. Finally, we expect to generate strong free cash flow from operations in combination with proceeds from asset sales to further reduce our debt leverage to approximately 2.75x by the end of 2021, which is significantly below our previous outlook of 3.0x. Our clients continue to embrace our integrated marketing offering, which is helping us meet our financial objectives of driving earnings and increasing margins through revenue growth, effective cost management, and productivity improvements, as well as reducing debt through the generation of strong free cash flow and cash generated from asset sales. All these efforts will continue to strengthen our balance sheet and liquidity to ensure we have the financial flexibility to continue to accelerate and scale our strategy and drive shareholder value. With that, I’d like to turn the call back to Katie, who will review questions compiled in advance of today's call.

Thank you, Dave. Because we compile questions in advance of today's call, we will not ask for callers to enter the queue. Thank you to everyone who submitted a question. We have 3 top questions that were submitted. The first question is on Print segment revenue. It reads, you have been highlighting print segment share wins more often than you have in the past. What are you seeing from a competitive standpoint?

Well, Katie, I'll take that. There clearly has been a lot of disruption in the past year in pretty much every business, but specifically in the legacy print business, there's been a lot of challenges. But I'm very proud of how we've managed through this, as we've just shown you and actually continue to shore up our balance sheet in a very positive way. And so what we're seeing now is just a lot of people looking for stability. We've seen an uptick of whether it's current clients asking us to do more or new logos coming into the fold, looking for stability. What's great about that is we've been able to bring on those clients so they can be exposed to all the other solutions we offer, just like our current clients have been. We show them that not only can we be efficient and reliable in putting their workouts, but also that we can actually work with them to help them sell more product. We look forward to not only the work we're picking up as part of this disruption from existing clients, but also from the new logos coming in. I'm very excited, because we can prove to them that we can be that partner and not only provide the stability of the legacy platform but also help them grow their businesses. So we're very excited about what we're seeing. Again, I think we've always done a very good job of managing through tough times to be able to come out on the other side stronger than we were at the beginning.

Our second question is regarding QuadExpress, and asks, can you give more detail on why QuadExpress was sold and how does QuadExpress differ from the broader logistics business that Quad will continue to run?

It's Dave, I'll take that one. QuadExpress, just as a reminder, was a non-asset-based third-party broker of logistics services for customers that we acquired as part of the World Color acquisition back in 2010. Over time, we've really grown this business nicely with a combination of expanded services they can offer and innovative technology, including the development of our SilverExpress transportation management system. Technology was a key part of growth for this business. However, QuadExpress is a much smaller part of our overall logistics offering. We're not selling our logistics business; we're just selling the brokered freight portion of it. As part of our established strategy to optimize our product and service portfolio, we are positioning ourselves as a marketing solutions partner that creates more value for our clients and shareholders. We're going to continue to operate a much larger and broader in-house global logistics business, which includes Quad transportation services and our trucking group, Duplainville Transport, to provide logistics services directly to our clients, as compared to the more brokered model of what QuadExpress was. I think the final thing I would say is we were very pleased by the outcome of the sale process. We realized a really attractive sales price of $40 million, and that represents over an 8x multiple of adjusted EBITDA. I think, as importantly, we found a buyer who can strategically grow and nurture the business like we had in the past and take it to different levels. So that's really good for the business and for our employees who are part of QuadExpress. We really thank those employees for their past decade of service to Quad; they've really been successful for us. I think it's a great outcome for QuadExpress, a great outcome for those employees, and for Quad. We can now better allocate that capital to accelerate growth in our marketing solutions group and further decrease debt.

Our final question relates to the 2021 outlook. It reads, can you speak more to client trends and what you are seeing going into the second half of the year that gives you confidence in raising your target?

Yeah. I think confidence is the keyword here. What we saw building throughout the last few quarters was growing confidence and improvement in demand for advertising and marketing products and services in our business as we've been exiting out of the peak impact of the pandemic. As our clients have improved, so have we. We have a lot of confidence coming out of the second quarter where we experienced significantly above our net sales forecast with 19% growth versus what we thought of 10% to 13% heading into the quarter. So really, that strength gives us a lot of confidence in how we've put out increased guidance for the rest of the year. The guidance for the back half of the year, in the full year, excludes the impact of the QuadExpress divestiture. We're increasing organic net sales growth forecast from slight down to flat to now 1% to 3% growth in 2021. It's really good, really important momentum for our business. Adjusted EBITDA is now expected to be in the range of $240 million to $260 million, which also has taken into consideration the EBITDA loss in the back half of the year resulting from the sale of QuadExpress. What we're pleased about is the tremendous progress we've made on the debt side. In the first half of this year, we've accomplished what we thought we could accomplish at the end of the year. Reducing to 3.0x leverage was a significant milestone for us and was earlier than we thought we could reach because we thought we could only get there by the end of the year. We're happy to achieve that earlier, and what's great is the momentum of the business is carrying us forward aided by some additional asset sales, where we think we'll achieve around 2x to 2.75x debt leverage by the end of the year at the midpoint of our adjusted EBITDA guidance. This represents all positive developments for our balance sheet and our business, positioning us excellently to continue strengthening our balance sheet, which we believe is one of the healthiest in the industry and the product segments in which we compete, while providing further capital for accelerating our transformation.

Yeah, and let me add some commentary because we do like to walk through the various categories we're in just to give you some color. Using a context of 6.5% GDP growth in the second quarter, retail inserts were actually flat for us. That has been and will continue to be the more challenged part of the portfolio, primarily due to the decline in newspaper carriers, etc. However, if you look at the rest of the categories, we really exceeded our market segment metrics across all categories. For instance, publications, periodical volume for the USPS in the quarter was down about 5%, but we were up 7% in press pages for the publication market. This reflects the quality of our clients and continued segment share wins as people look for stability. On the catalog side, the industry as a whole experienced a nice bounce-back of about 19% in the quarter, and Quad was up over 26%, showcasing segment wins we've been accumulating. Additionally, direct mail saw a nice rebound, with the industry up about 39% while we were up 41%. Our packaging sales grew by 11% in the quarter, while the industry was up between 5% and 10%. I am excited by this growth, and I’m particularly proud that our entire services offering, where we have been investing a lot in agency solutions and related areas, was up 33% in the quarter and 15% year-to-date. This reinforces my point about building momentum and showing our clients that we can help them improve as brands. Despite this momentum, I do remain cautious about the Delta variant and labor shortages. We've done a good job of hiring and retaining staff, but we will keep an eye on the Delta variant's impact. The post office is increasing our rates pretty dramatically in August, and while we haven't observed much impact yet, we will monitor it closely. Overall, despite these challenges, we are very confident in our future outlook and dedicated to true growth. We will continue to update you.

Well, this concludes the Q&A portion of today’s call. Now I would like to turn the call back to Joel for closing remarks.

Thank you, everyone, for joining today’s call. I again want to congratulate our employees on our company’s milestone 50th anniversary and our legacy of creating a better way every day. I’m confident in our team and our strategy and in our future as a marketing solutions partner that helps brands and marketers solve their marketing and process challenges. As the ad market and broader economy continue to recover and return to growth, our innovative team remains committed to creating new revenue from our expanded marketing services offering. Thank you, and we’ll talk to you next quarter.

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