Earnings Call Transcript - QUAD Q3 2022

Operator, Operator

Good morning, ladies and gentlemen, and welcome to Quad's Third Quarter Conference Call. Please note today's event is being recorded. At this time, I'd like to turn the conference call over to Claire Ho, Quad's Director of Corporate Communications. Claire, please go ahead.

Claire Ho, Director of Corporate Communications

Thank you, operator, and good morning, everyone. With me today are Joel Quadracci, Quad's Chairman, President and Chief Executive Officer; and Tony Staniak, Quad's Chief Financial Officer. Joel will lead off today's call with a business update, and Tony will follow with a summary of Quad's third quarter 2022 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, adjusted diluted earnings per share, free cash flow, net debt 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.

Joel Quadracci, Chairman, President and CEO

Thank you, Claire, and good morning, everyone. I'm pleased to report that in the third quarter, we delivered better-than-expected net sales of $830 million, an 18% increase. This was the sixth consecutive quarter of sales growth for Quad and reflects continued print segment share gains, increased pricing in response to inflationary cost pressures, and increased sales in our international locations. Our focus as a marketing experience company is driving segment share gains and new client wins. And as a result, we are raising our full year net sales guidance range from 3% to 7% growth to 8% to 10% growth. We've also narrowed our other guidance within the previously provided ranges to reflect our results through the first 9 months of the year, which Tony will cover later in the call. I am pleased to share that the proactive investments we made in labor, inventory and equipment during the first half of 2022 are paying off now during our seasonally high production period. As a result, we achieved higher adjusted EBITDA in the third quarter on both a year-over-year and sequential basis. Notably, we are positioned to achieve higher year-over-year earnings in the fourth quarter as well. Despite ongoing challenges from macroeconomic headwinds, we continue to monitor and take action to mitigate inflationary cost pressures and supply chain constraints, including an inflationary offsetting price increase that will become effective January 1, 2023. Overall, we remain nimble and ready to adjust our operations as necessary to enhance our financial strength while continuing to serve our clients well. Slide 4 shows how we continue to diversify our revenue into higher value and higher-margin offerings. On a year-to-date basis, this helped us grow net sales by 14% when excluding the impact of the QuadExpress divestiture. Net sales grew in our targeted print and international segments, while large-scale print decreased as a percentage of total net sales due to expected organic declines, primarily in retail inserts. The increase in our international segment is primarily driven by stronger sales in Latin America. For example, Mexico sales have been bolstered by higher exports into the U.S. and Mexico is proving to be a high-quality, low-cost alternative to Asia. Turning to Slide 5, we are proud of the effectiveness of our business strategy to sustain our leadership in commercial printing while also transforming into a marketing experience company. The world's best brands increasingly recognize the unique value we provide through our holistic, multichannel, through-the-line marketing solutions. As a marketing experience company, we guide brands through every effort intended to drive action, from consumer awareness and trust to brand preference and purchase. We will continue to give our clients a more streamlined, flexible and frictionless way to go to market and reach consumers while enhancing our competitive position to drive profitable growth. On Slide 6, we highlighted our 3 key competitive advantages: integrated marketing platform excellence, innovation and culture and social purpose. We continue to strategically invest in our platform, including creative, analytic, print and production capabilities. Recent investments include advancements in data signals, insights and analytics, and next-gen printing capabilities with 100% variable print. We also continue to invest in our talent, bringing aboard experienced professionals to support our integrated offering and accelerate sales growth. In addition, we just opened a new location at 30 Irving Place in New York City, right in the heart of the Union Square District. The location is a strategic investment in our brand and will not only serve our local talent but provide a space to boost clients' marketing experience through conversation, collaboration and sales interaction. As a marketing experience company, we are making investments in brand marketing, including introducing Quad to new and expanded audiences as shown on Slide 7. In October, we participated in Advertising Week in New York and the Masters of Marketing Annual Conference in Orlando to strengthen existing client relationships and uncover new partnership opportunities for applying our unique technology and scalable solutions. During the quarter, we also facilitated thought leadership discussions among senior brand marketers from Fortune 500 and other leading companies within the brand innovators community. This week, our Chief Marketing Officer, Josh Golden, is speaking at the Annual Forbes CMO Summit in Miami, where he will provide insights about the marketing industry's need for a differentiated through-the-line offering to help us close the persistent gap between creative and production. Next week, we will host our Quad Packaging Sustainability Symposium for clients where we will address sustainability trends, new legislation about greenwashing and product recyclability and perspectives from Quad clients, including CVSHealth Corporation and the Kodiak Cakes brand. As part of the symposium, attendees will be able to tour our packaging insight location in Greenville, South Carolina, and learn how we test brand packaging performance, consumer attention and shelf impact in a simulated shopping environment using advanced biometric technologies. Turning to Slide 8, we are growing our presence with brands in the critical expansion categories of finance, health care, retail, consumer packaged goods and direct-to-consumer. For example, a large and complex legacy brand insurance and financial services company chose to expand our relationship to include integrated, creative and media solutions. The company was looking for fresh ideas to creatively bring its brand story to life across all business lines as it transforms from an institutional agent-first model to a digitally savvy direct-to-consumer model. The company also wanted to make better use of the data to connect more effectively and authentically with consumers. We were already exceptionally familiar with the company, having successfully partnered with it on direct mail production for more than 15 years. We presented an integrated strategy propelled by audience insights and consumer connections planning for driving peak performance through data-driven orchestration of the right brand actions in the right moments for the right audiences. We also introduced the client to our solutions for advanced measurement and accountability to quantify and predict the impact of its marketing efforts. While our work for this client is only just getting underway, we are proud to be the digital agency for 3 of its most important business lines. We successfully competed against some of the largest agency holding companies for this quarter. On Slide 9, we show how we drive business results for our clients through a relentless focus on innovation, even on things as standard as mailing envelopes. Knowing that marketers face a new set of challenges with the cookie-less future, we spearheaded a campaign for Sirius XM that fully integrated both digital marketing with traditional mail and data capture and a focused target market. One-to-one flow codes on a highly designed and engaging outer envelope increased customer interactions by 30% and delivered first-party user scan data for the client to better identify audiences and their passions. This innovation is just one more way we are helping our network of brands, publishers and direct marketers monetize their offline and online media more effectively. On Slide 10, we highlighted our third competitive advantage, commitment to culture and social purpose. We continuously create a better way through our approach to environmental, social and governance matters. In fact, Quad's ESG strategy has been validated by trusted third parties such as EcoVadis, which recently awarded Quad a Bronze Medal for the quality of our ESG strategy, and the Wisconsin Sustainable Business Council, which just awarded us Green Master status for our sustainable business actions. We also just released our 2022 ESG update, which details progress on our commitments to create positive sustainable change. The update is available for viewing and download on quad.com, or you can scan the flow code shown on Slide 10 of today's presentation. When it comes to the environment, we have multiple initiatives in place to reduce our environmental impact. We are also committed to environmental education and are pleased to share we are featured on a new episode of the Emmy award-winning video series, Into the Outdoors, which regularly airs on PBS. We were selected to be part of the programming for our commitment to environmentalism, sustainability and stewardship, including our work to galvanize the next generation of environmental stewards. To see the episode, scan the other flow code on Slide 10. In the social space, we are advancing on our goal to build a more comprehensive and sustainable DEI strategy that not only benefits our employees but also our industry and the communities we call home. Our DEI task force is taking action, implementing projects that foster a culture of inclusion with measurement and monitoring to hold ourselves accountable. While we still have work to do, Quad is advanced on several social commitments, including improving the representation of women and people of color among our U.S. employee base and U.S. management team. In particular, our Agency Solutions Group has made gains in attracting more diverse talent since implementing more inclusive hiring practices. We also just opened a new recruiting and training hub based in Milwaukee Central City. We are working with the community to remove barriers to employment such as training and transportation and create greater awareness around career opportunities with growth trajectories. This location builds on the momentum established with trusted community partners such as Running Rebels and the BrandLab. Turning to Slide 11. Before I turn the call over to Tony, I want to recognize our very own Kelly Burt, Vice President of Sales and Business Development for In-Store, for being recognized among the 2022 Women of Excellence by the Path to Purchase Institute. Kelly, who was lauded for excellence in business management, including growing new business and market share with integrity and creativity, was recognized along with leaders from other large brands such as PepsiCo and Albertsons. So congratulations, Kelly. On a more personal note, I was honored to see my late mother and Quad Co-founder, Betty Quadracci, recognized for advancing inclusive leadership in the Wisconsin business community. In October, Milwaukee Women Inc. celebrated Betty for her role in founding their organization, which is focused on achieving balanced representation of women on Boards of Directors. I'm proud of my mother's lasting legacy to maximize the performance of Wisconsin businesses. I will now turn the call to Tony for a financial review.

Anthony Staniak, Chief Financial Officer

Thanks, Joel, and good morning, everyone. Slide 12 provides a snapshot of our third quarter 2022 financial results. As Joel highlighted, we continue to be pleased with our consistent net sales growth. Compared to 2021 and excluding divestitures, we achieved 9% growth in the first quarter of 2022, 14% growth in the second quarter and 18% growth in the third quarter. This now represents 6 consecutive quarters of year-over-year net sales growth going back to the second quarter of 2021. In addition, the proactive investments we made during the first half of the year in hiring and training labor proved effective during the third quarter, driving strong operational performance, very high client satisfaction with on-time deliveries and increased adjusted EBITDA from the prior year. We expect adjusted EBITDA growth in the fourth quarter also. We are closely monitoring the economy and will remain disciplined with our capital allocation. Our primary focus heading into the fourth quarter remains debt reduction. While our debt leverage ratio increased to 3.07x as of September 30, 2022, I want to remind our audience that the third quarter is traditionally our annual high point for working capital. Thus, we believe that with the seasonally strong fourth quarter free cash flow we have projected, we will achieve the year-end debt leverage guidance of approximately 2.25x. We also repurchased 3.1 million shares of Class A common stock, which represents more than 5% of Quad's outstanding shares for $10 million year-to-date. We will continue to pursue opportunities with our share repurchase program at times in the future. Net sales were $830 million in the third quarter, up 18% from 2021. On a year-to-date basis, net sales were $2.3 billion, up 11% from 2021. After excluding the 2021 QuadExpress divestiture, net sales increased 14% for the 9-month period compared to the same period in 2021. Net sales growth was achieved due to print segment share gains, increased pricing in response to inflationary pressures and increased sales in our international locations. We will continue to be nimble with our pricing to mitigate the negative impacts of supply chain disruption and cost inflation. Adjusted EBITDA was $69 million in the third quarter of 2022, as compared to $55 million in the third quarter of 2021 when excluding a $13 million nonrecurring gain from a property insurance claim in 2021. The adjusted EBITDA increase of over 25% was driven by continued sales growth and proactive investments made in labor, inventory and equipment during the first half of 2022, to increase production efficiency in the second half of 2022 during our seasonally higher production period. On a year-to-date basis, adjusted EBITDA was $173 million in 2022 as compared to $201 million in 2021. The decline in the year-to-date period was primarily due to cost inflation, investments made in hiring and training labor in the first half of the year, the negative impact of supply chain disruptions on our productivity and a $13 million gain from a property insurance claim in 2021, which were partially offset by increased earnings from net sales growth. Adjusted diluted earnings per share was $0.32 in the third quarter of 2022, a 78% increase compared to $0.18 in the third quarter of 2021. This increase was primarily due to increased recurring earnings and was also benefited by our recent stock buybacks. Year-to-date, adjusted diluted earnings per share was $0.49, consistent with $0.50 in the same period last year. Free cash flow decreased $60 million to negative $80 million for the first 9 months of 2022, primarily due to higher working capital driven by inflationary cost increases, supply chain disruption and higher net sales. We also invested $50 million year-to-date in capital expenditures, consistent with our long-term automation strategy. We will continue to invest in our business to seize opportunities including accelerating our growth, winning additional segment share and/or reducing our costs. As a reminder, the company historically generates the majority of its free cash flow in the fourth quarter of the year. Slide 13 includes a summary of our debt capital structure. Net debt increased by $91 million to $715 million at September 30, 2022, as compared to $624 million as of December 31, 2021. And the debt leverage ratio increased 68 basis points to 3.07x at the end of the third quarter. The increase in net debt and the debt leverage ratio was primarily due to the investment in working capital in preparation for our peak production season. When removing the impact of seasonality, over the past 12 months, net debt decreased $84 million, representing a reduction of over 10% in our net debt. Our long-term target leverage range is 2 to 2.5x, and with the expected seasonally strong fourth quarter cash flow, we continue to believe we will achieve the midpoint of 2.25x by the end of the year. During the third quarter, we maintained our strong liquidity with up to $245 million of availability under our revolving credit agreement and $14 million of cash on hand. Our nearest significant debt maturity is $88 million occurring in January 2024, and the vast majority of the debt maturities are not due until late 2026. Our 2022 guidance has been updated as shown on Slide 14. Our annual net sales growth range, which was originally 3% to 7% growth, is now projected to increase to 8% to 10% growth. As we are now three-fourths of the way through the year, we are also narrowing our other guidance ranges. All of the following updated guidance is within the ranges we previously provided. The adjusted EBITDA guidance range is $235 million to $255 million. Free cash flow guidance range is $70 million to $90 million. And year-end debt leverage guidance is unchanged at approximately 2.25x. Our financial objectives include accelerating our business as a marketing experience company to fuel net sales growth, driving profitability through sales growth, effective cost management and productivity improvements, maintaining a strong balance sheet with a primary focus on reducing debt through the generation of strong free cash flow as well as a balanced approach to capital allocation, including pursuing opportunities to return capital to shareholders through stock buybacks or dividends. These efforts will further strengthen our balance sheet and liquidity, enhancing our financial flexibility to accelerate and scale our strategy as a marketing experience company while driving shareholder value. With that, I'd like to turn the call back to Claire for questions.

Claire Ho, Director of Corporate Communications

Thank you, Tony. Because we compiled 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 4 questions that were submitted. Our first question relates to industry and segment trends and asks you highlighted print segment share gains and increased international sales as 2 contributors to strong sales growth. Can you provide some additional commentary on those areas and also comment on any trends you're seeing across the other industries and segments you operate in?

Joel Quadracci, Chairman, President and CEO

Thank you for the question, Claire. International sales have been a strong contributor, particularly in our Mexican operations, and we anticipate this success will extend to other parts of South America. We are seeing significant market growth, which has positively influenced our product mix. Regarding our core print product lines, it's essential to highlight where we observe declines and growth. Large-scale print consists of retail inserts and publications. Retail inserts declined by about 20% this quarter, which aligns with our previous expectations due to a gradual shift away from newspaper-distributed products as circulation decreases. Within retail inserts, grocery tends to remain more stable compared to big box retail, but we expect the overall decline to persist. However, we are expanding our offerings for retailers, as they still require consumer engagement despite this decline. This includes an increase in direct mail sales and in-store signage, which are important avenues for retail clients that benefit from our products. Publications have also experienced a consistent decline, down about 15% this quarter, largely influenced by portfolio adjustments from a change in ownership of one client, leading to the discontinuation of long-established titles. We anticipate that publications will remain important in the long term, and we have strategies to manage their decline. On the other hand, targeted print—which includes catalogs, direct mail, packaging, and in-store materials—tells a different story. For catalogs, we've seen a 10% increase this quarter, driven by organic growth and market share gains. Although the overall direct mail industry fell by 11%, our volume only declined by 1%, while our revenue increased by 18% due to inflation, higher paper sales, and a shift towards more complex targeted direct mail products. In packaging, we experienced over a 15% increase as we focused on value-added products like higher-end COVID tests, which have established new relationships that we expect to grow beyond just COVID tests. This has allowed us to streamline our offerings and move away from low-margin products like pasta boxes. In-store revenue rose by 19% this quarter, buoyed by new client acquisitions and increased market share. Overall, while we manage the decline in large-scale print, we are successfully offsetting it through targeted print initiatives and expanding into agency solutions with new clients, summarizing what we experienced this quarter.

Claire Ho, Director of Corporate Communications

Thank you, Joel. Our next question is regarding the current economy and its impact on retail clients. It asks, can you comment on any areas of the business that may be starting to see some impact from the recent economic downturn? How much of your business is tied to retail and apparel customers that are noting slowdowns?

Joel Quadracci, Chairman, President and CEO

I think it’s a mixed situation. Retailers have been struggling all year with excess inventory due to previous supply chain issues, resulting in some ending up with the wrong stock. One noticeable change we’ve observed this fall is a shift in how retailers approach Black Friday, which usually generates significant sales in a brief period. Many retailers have announced a move away from that strategy. We’re uncertain if this is indicative of a lasting trend or just a temporary shift, and many are still trying to understand it. We’re closely monitoring the situation. However, considering the market share gains we’ve achieved and our ability to respond quickly, which we have demonstrated in the past, we feel ready for whatever economic challenges may arise.

Claire Ho, Director of Corporate Communications

Our next question is regarding supply chain constraints. It asks, can you provide some commentary on any supply chain constraints you experienced during the quarter? How has Quad positioned itself to ensure it has the necessary paper inventory and labor to fill its peak demand?

Joel Quadracci, Chairman, President and CEO

Yes. There are two main points to address: supply chain and labor. The primary issue in the supply chain has been paper shortages due to disruptions in available capacity, as some of it has been redirected to other areas of the packaging industry or has shut down based on demand fluctuations. However, we managed to navigate this situation effectively this year by purchasing ahead and collaborating with mills and customers. This approach contributed to our increased working capital, ensuring we had enough paper for printing. Additionally, we worked closely with many of our clients to manage this challenge. Going forward, we will need to continue navigating paper supply issues, but we are well positioned to handle them. Other supply chain challenges are also being managed. While the situation is still complex, it has improved compared to earlier times, and we feel confident about our status there. The second aspect is labor, which we discussed extensively last year due to the low unemployment rate. In light of the current circumstances, we began hiring much earlier to maximize the time available for preparation ahead of our busy season, rather than following our usual timeline. This strategy involved wage increases and a comprehensive approach to attracting and retaining workers. It's important to note that in a low unemployment environment, turnover tends to be high, which we've been addressing diligently. I'm pleased to report that during this busy season, we were initially 700 people short compared to last year, but we have managed to meet our staffing needs and even slowed our hiring due to our success. This has enabled us to navigate the busy season with minimal issues, and our on-time delivery performance has exceeded our expectations given the challenges we faced last year.

Claire Ho, Director of Corporate Communications

Thank you, Joel. Our last question is regarding stock buybacks. It asks, with the increasing share repurchases you have done as of late, do you anticipate continuing these levels of repurchase activity in the near term? Any additional insight you can provide on how you're thinking about repurchases and your capital allocation priorities going forward?

Joel Quadracci, Chairman, President and CEO

Yes. Thanks, Claire. As we said last quarter, we're going to pursue opportunities to repurchase shares. We did that recently based on where the share price was. We felt that there was good value there, and it was a compelling use of capital. And we will do that in the future when we feel there is a compelling use of capital. We repurchased over 5% of our outstanding shares. We purchased dilution that had taken place over the years on the equity grants. And again, as part of balanced capital allocation, we will look for opportunities in the future when it makes sense.

Claire Ho, Director of Corporate Communications

Thank you, Tony. This concludes the Q&A portion of today's call. And now I would like to turn the call back to Joel for closing remarks.

Joel Quadracci, Chairman, President and CEO

Thank you, Claire, and thank you, everyone, for joining today's call. I just want to close by reiterating my thanks to our employees for their continued hard work, especially during our peak demand for our products and services. I remain very confident in our team and our strategy and in our future as a marketing experience company that helps brands reimagine their marketing to be more streamlined, impactful, flexible and frictionless. With that, thank you again, and have a good day. We look forward to speaking with you next quarter.

Operator, Operator

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