Earnings Call Transcript - QUAD Q3 2024

Operator, Operator

Good morning and welcome to Quad’s Third Quarter 2024 Conference Call. During today’s call, all participants will be in listen-only mode. 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 the earnings release. Alternatively, you can access the slide presentation on the Investors section of Quad’s website under the Events and Presentations link. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I will now turn the conference over to Katie Krebsbach, Quad’s Investor Relations Manager. Katie, please go ahead.

Katie Krebsbach, Investor Relations Manager

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 today’s call with a business update, and Tony will follow with a summary of Quad’s third quarter and year-to-date 2024 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 will be available on the Investor 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, Katie, and good morning, everyone. Our third quarter results were in line with our expectations. Third quarter net sales declined versus prior year due to lower paper and agency solution sales. However, we achieved improvements in both adjusted EBITDA and adjusted EBITDA margin, with adjusted EBITDA margin increasing by 54 basis points to 8.7%. We also continued to be a strong cash generator, using these funds to pay down debt, strengthen our balance sheet and return capital to shareholders through a quarterly dividend. Despite full year 2024 net sales trending toward the higher end of decline in our guidance range, we are maintaining the midpoints of our guidance for adjusted EBITDA and free cash flow. We are also reducing anticipated year-end net debt leverage from approximately 1.8 times to 1.5 times pending the sale of the majority of our European operations by year-end. As announced last week, we entered into a definitive agreement with Capmont, a Germany-based private capital investment management firm, to sell our European Print operations for an enterprise value of approximately $45 million, operations that represent just 5% of our total net sales. This proposed sale supports Quad's ongoing strategic focus to optimize our business portfolio for growth as a marketing experience company. We will continue to maintain state-of-the-art print operations in locations that support our MX offering, including the Americas, with North America comprising our largest base of operations. The transaction is expected to close by the end of the year pending customary regulatory clearances and other closing conditions. As a company founded on creating a better way, we continue to use every tool at our disposal to improve the marketers' experience. Our solution suite helps brands enhance their marketing experience by removing friction wherever it appears across the marketing journey from creative production and media to everywhere in between. Supported by state-of-the-art technology and data-driven intelligence, our solutions are scalable and flexible, operating together to provide clients with integrated service excellence. Our focus as an MX company includes accelerating our position in market value, leveraging ingenuity and innovation, relentlessly solving marketers' biggest challenges across industries, and building on our strong culture as an MX company. Moving on to Slide 5, I'm proud to share how we are continuing to enhance our media intelligence solutions through the power of a proprietary household-based data stack, comprised of more than 3 billion data points that are revalidated weekly. Our data stack represents more than 20,000 attributes from approximately 97% of the adult U.S. population. We are leveraging this robust data set to power our audience targeting solutions and help clients optimize customer acquisition efforts while creating engaging content for their existing customers. In September, we announced our next step in monetizing our data stack through an exciting partnership with Google Cloud. By leveraging Google Cloud's artificial intelligence optimization capabilities and large language models, we are creating new AI-driven solutions that tap into our data and seamlessly connect it with clients' creative and media. In addition to streamlining access to Quad's audience targeting capabilities, these combined solutions will provide highly personalized content at scale across multiple marketing channels via image generation, content creation, layout design, translation, and more. We plan to roll out our new AI-driven offerings in the coming months. Next, I'd like to spotlight two client examples that showcase the measurable benefits of our MX Solutions Suite. Advancing to Slide 6, Nicklaus Children's Hospital, a nationally ranked children's healthcare system in Miami, partnered with our Rise Media agency to revise its marketing strategy. The focus of our work was to maintain reach while adhering to new guidelines for healthcare marketers related to heightened privacy regulations. With our help, the hospital implemented a refreshed campaign strategy that ensured compliance while increasing engagement. Our work included a complete creative refresh to its various ad formats, including increased usage of video content, a refined paid media strategy that enhanced ad relevancy, increased web traffic, and an updated SEO strategy that improved the hospital's metadata and identified and addressed content gaps. These integrated efforts led to a 93% higher click-through rate and a 375% higher engagement in paid social media ads year-over-year, and a 68% growth in website traffic. The client is extremely pleased with these results from our ongoing partnership and we look forward to supporting continued growth for this client as its media agency of record. Specifically, we applied our proprietary household-based data stack and advanced analytics to identify and reach high-potential audience targets, designed and optimized creative content for both online and offline channels, and designed a printed direct mail to drive online conversions with flowcode technology. The campaign combined the power of digital and print by supplementing mail pieces with targeted social media and website ads, as well as remarketing web-based consumer leads with personalized mailings. The results of the campaign included high engagement and email open rates, reinforcing the value of well-conceived and connected multichannel marketing campaigns. Before I turn the call over to Tony, I would like to take a moment to thank our employees during our seasonally busiest time of the year for their continued hard work and commitment to providing the highest levels of service for each of our clients. I'm proud of our team and our future as an MX Company. And with that, I will now turn the call over to Tony for the Financial Review.

Tony Staniak, CFO

Thanks Joel and good morning everyone. On Slide 8 we show our diverse revenue mix. Net sales were $675 million in the third quarter of 2024, a decline of 4% compared to the same period in 2023, primarily due to lower paper and agency solution sales, including the loss of a large grocery client. On a year-to-date basis, net sales were $2 billion in 2024, a 9% decline compared to 2023 primarily due to lower paper sales and lower print volumes, including the impact from client mix and increased gravure volume that has a lower unit price with a higher profit margin, as well as lower agency solution sales. During the first nine months of 2024, magazines and catalogs increased as a portion of our net sales mix by 2% compared to the previous year due to recent segment share wins such as AARP, while retail inserts decreased 2%. Slide 9 provides a snapshot of our third quarter 2024 financial results. Adjusted EBITDA was $59 million in the third quarter of 2024 as compared to $57 million in the third quarter of 2023, and adjusted EBITDA margin increased 54 basis points from 8.2% to 8.7%. On a year-to-date basis, adjusted EBITDA was $161 million in 2024 compared to $168 million in 2023, and adjusted EBITDA margin increased 48 basis points from 7.7% in the first nine months of 2023 to 8.2% in the first nine months of 2024. The margin increase in both periods was primarily due to benefits from improved manufacturing productivity and savings from cost reduction initiatives. During the first half of 2024, we completed previously announced restructuring actions, including plant closures and labor reductions that we expect will generate $60 million of cost savings this year. Adjusted diluted earnings per share was $0.26 in the third quarter of 2024 as compared to $0.11 in the third quarter of 2023. Year-to-date adjusted diluted earnings per share was $0.49 in 2024 compared to $0.28 in 2023. The increase in both periods was primarily due to higher adjusted net earnings and the beneficial impact of a lower share count due to stock buybacks. Since the second quarter of 2022, we have repurchased approximately 11% of our total outstanding common stock. Quad's Board of Directors authorized a share repurchase program of up to $100 million of our outstanding Class A common stock in 2018. As of September 30, 2024, there were $77.5 million of authorized repurchases remaining under this program. Free cash flow was negative $92 million in the first nine months of 2024 as compared to negative $18 million in the first nine months of 2023. This change was primarily due to nonrecurring cash flow benefits realized in 2023 from reducing inventories enabled by an improved supply chain environment. As we have previously shared, we will continue to generate proceeds from asset sales in addition to our strong free cash flow as shown on Slide 10. During the five-year period from 2020 to 2024, we now expect to generate over $830 million of free cash flow and proceeds from asset sales. These asset sales include divestitures of certain noncore portions of our business like the expected year-end sale of the majority of our European operations for an enterprise value of approximately $45 million, as well as sales of property, plant, and equipment from closed facilities. In September, we completed the sale of our former Saratoga Springs, New York, 1 million square foot manufacturing facility for net cash proceeds of $41 million, and last week we announced the closure of our Waukee, Iowa Directory manufacturing facility. We expect to generate further cash proceeds in 2025 from the sale of the Waukee building and three additional owned facilities we closed earlier in 2024. We show the seasonality of our free cash flow and debt leverage on Slide 11. Due to the seasonality of our business, we typically generate negative free cash flow in the first nine months of the year, followed by large positive free cash flow in the fourth quarter. Our seasonal production peak occurs in the late third quarter and early fourth quarter of the year due to the timing of holiday-related advertising and promotions. This leads to inventory buildup prior to that time and subsequently results in higher collections from clients in the fourth quarter. In 2024, we continue to anticipate a similarly seasonal pattern, more comparable to 2022 when we generated $174 million of free cash flow in the fourth quarter. We believe we are on track to generate $142 million to $162 million of free cash flow in the fourth quarter this year to meet our full year 2024 free cash flow guidance of $50 million to $70 million, and we plan to achieve net debt leverage of approximately 1.5 times with net debt of $330 million pending the completion of the European divestiture. Slide 12 includes a summary of our debt capital structure. At the end of the third quarter of 2024, our net debt was $490 million, reduced by $94 million from $584 million one year ago on September 30, 2023. We have focused on debt reduction over the past five years, and by this year-end, we anticipate reducing debt by over $700 million since January 1, 2020. Including interest rate derivatives, our debt at the end of the third quarter was 57% floating and 43% fixed with a blended interest rate of 7.8%, and our total available liquidity, including cash on hand, was $196 million. We are pleased with the October extension of our $690 million term loan A and revolving credit agreement and the ongoing long-term support and partnership with our premier bank group. Our next significant maturity is now $193 million due in October 2029. We will continue to focus on debt reduction with our capital allocation. This debt extension also provides us with additional financial flexibility to focus on the growth and development of our offerings as a marketing experience company while also returning capital to our shareholders. We share our updated 2024 guidance as shown on Slide 13. Consistent with what we communicated in the second quarter earnings call, our annual net sales are trending toward the higher end of decline in our guidance range, and we expect a decline of approximately 9% compared to the original guidance of annual net sales declining 5% to 9%. With our flexible model, higher labor productivity, and focus on disciplined cost management, we are maintaining the midpoints of adjusted EBITDA guidance at $225 million and free cash flow guidance at $60 million. Free cash flow includes $65 million of capital expenditures to further accelerate our offerings. And finally, as previously mentioned, enabled by our strong cash generation, we now expect debt leverage to improve to approximately 1.5 times by the end of 2024, which is reduced from our original guidance of 1.8 times and is also below our targeted long-term debt leverage range of 1.75 to 2.25 times. Slide 14 includes our key investment highlights as we continue to build on our momentum as a marketing experience company. We believe that Quad is a compelling long-term investment and we remain focused on growing net sales and driving higher profitability through continued diversification of our revenue and clients. With our expanded offerings such as In-Store Connect and our proprietary household-based data stack discussed earlier, there is a significant addressable revenue opportunity with both our large base of existing clients as well as new clients. In addition, our strong cash generation will continue to fuel our capital allocation priorities. These include investing and scaling our offerings, further reducing debt, and returning capital to shareholders through our next quarterly dividend of $0.05, payable on December 6th. We also expect to continue to be opportunistic in terms of our future share repurchases. We look forward to sharing a more comprehensive update on our strategy and growth opportunities at our upcoming Investor Day on November 20th in New York City. With that, I'd like to turn the call back to our operator for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Kevin Steinke with Barrington Research Associates. Please go ahead.

Kevin Steinke, Analyst

Thanks and good morning. Great, well I wanted to start out by asking about the partnership with Google, which looks like a really exciting and intriguing announcement. I know you said you're going to be rolling that out in the coming months, but have you gathered any initial feedback or initial reaction from your client base and how they see this benefiting them?

Joel Quadracci, Chairman, President and CEO

Yes, I mean, I think one of the biggest challenges in marketing today is finding good audience, and the other big challenge, once you find a good audience, is actually having the content follow the messaging in a variable sort of way. The old days of sort of shotgun blasting everyone with the same message and content don't work so well, so the world expects to be more personalized. By adding the AI element to our very large data stack—and I'll remind you that the data stack consists of all the household personalities in the country because of our existence as a printing company, where we manage a significant volume of marketing mail—we're going to every mailbox across the country with content. We know what content is going in, which creates the personality knowledge of each household. So, once you have that, it's about digging through that huge data stack to find out what is the specific set of data that works. AI helps us sift through that as opposed to relying solely on a team of data scientists. Once we identify that audience using AI, we can also auto-generate content in text and visual formats. For example, a customer interested in horticultural products may have different preferences, so we want to provide tailored content accordingly. This is crucial because it solves a problem that most of our marketing customers face today. The response so far has been that people are eager to jump on and start testing the content and the data.

Kevin Steinke, Analyst

That sounds great. I was wondering, with this new set of tools in your pocket, if you feel like this is something you can go out to the market as a differentiator to market yourself and win new business.

Joel Quadracci, Chairman, President and CEO

Yes, absolutely. We've been working on this for a while, and it's all coming together, combining it with our media offering and analytics offering. Our approach is to be completely transparent about where we spend media dollars. This isn’t always the case elsewhere, where there can be a lot of ambiguity about spending the right amounts on the right audiences. The demand for both transparency and specificity in audience targeting is strong. I believe this will be a significant differentiator for us.

Kevin Steinke, Analyst

Excellent. I wanted to follow up by asking about the reduction in your year-end leverage ratio target. Is that, as I understand it, driven specifically by the sale of European operations?

Joel Quadracci, Chairman, President and CEO

It's a combination of factors. This has been a very busy quarter for us. Not only did we increase our margin, but we also divested operations in Poland and sold our high-quality asset in Saratoga Springs to a good owner for the community. So, it’s a combination of all those factors.

Kevin Steinke, Analyst

Okay. And as you think about targeted leverage ratio, you expect to come in below the target at year-end 2024. Will you keep the same target or will you consider revising that in the future?

Tony Staniak, CFO

Hi Kevin, we look at that every year, once a year and release that with our February earnings call. So, we will come back to you at that point. We're committed to maintaining low debt levels going forward, and we're happy with the low leverage. It provides us with flexibility to expand our offerings.

Joel Quadracci, Chairman, President and CEO

Yes, the situation raises questions about capital uses. I really appreciate what we've done with our balance sheet because it gives us optionality, whether that’s through returning capital to shareholders via dividend or past repurchases, or enhancing our capabilities. So, having a lower leverage range is advantageous, but we may adjust depending on opportunities.

Kevin Steinke, Analyst

Yes, that makes sense. It certainly gives you more options on capital allocation. So that's great. And just when I think about the sales trending toward a 9% decline for the full year, I assume the European sale is not factored into that, or is it? You mentioned year-end 2024 for the sale—if it potentially closes before that, could it affect the full year sales outlook?

Tony Staniak, CFO

Yes, due to regulatory clearances and other customary conditions, we expect to close the sale sometime in December, so it won't have a significant impact on the guidance if it closes, say, December 15th or so. Therefore, you should focus on the anticipated 9% decline as we indicated previously, taking into account the impact from the loss of the large grocery client, which amounts to about 3% of that decline. So, the second half is playing out as we expected.

Kevin Steinke, Analyst

Okay, that sounds good. Lastly, when you discuss the sales outlook, can you provide insights into client reactions to higher postal rates and interest rates? Are they growing more confident in a potential reduction of interest rates and a better economic outlook?

Joel Quadracci, Chairman, President and CEO

Yes, the postal increases we've faced over the past few years have had considerable impact, and that continues to affect us this year. While customers were aware of this increase, it was very sudden last year during the budgeting process. Even though they planned for another expected increase after this year, challenges remain as they still intend to increase rates in the second half of the year. On the positive side, customers are at least preparing for this. However, cumulatively, past increases have impacted volumes and contribute to that 9% decline. I hope that as consumer confidence rises with improved interest rates, volumes will start to recover. To clarify, we haven't seen a direct correlation from our customers on this issue. In the CPG sector, for example, some softness is noticeable, especially among lower-end consumers who are experiencing a greater pullback on higher-end items, while middle and upper-tier consumers are still spending reasonably well. The picture is very varied among our clients currently, and I’d characterize it as somewhat negative to neutral.

Kevin Steinke, Analyst

Okay, thanks for the update. Lastly, I wanted to inquire about your Mexico and Latin America operations. Could you provide an update on business trends there and whether you consider it a core part of your portfolio in the Americas?

Tony Staniak, CFO

Yes. I’ll start with our Mexico operations. It's a natural extension of our U.S. print platform. We export a significant volume out of Mexico to the United States and had a particularly strong third quarter in Mexico this year. Therefore, we remain optimistic about opportunities there. Colombia and Peru can also serve as extensions as we engage further across South America. As Joel stated in the prepared comments, we are a marketing experience company across the Americas.

Kevin Steinke, Analyst

Okay, thanks for all the good commentary. I will turn it over now.

Joel Quadracci, Chairman, President and CEO

Thanks, Kevin. Operator?

Operator, Operator

Yes. The next question comes from Barton Crockett with Rosenblatt. Please go ahead.

Barton Crockett, Analyst

Good morning, guys. Thanks for taking the question. I just, I guess a little bit about the numbers here to make sure I understand. So the implied 9% full year guidance suggests about an 8% decline in the fourth quarter, is that correct? Why would it be a little bit more pressured than the third quarter? Is it mainly just the mix from the grocery client you lost or is there something else happening?

Joel Quadracci, Chairman, President and CEO

Yes, you've got it right. We generally expect an 8% to 9% decline in fourth quarter sales to meet our approximately 9% full year decline target. You can see variations based on monthly volume outcomes as well. For instance, retail inserts were particularly low in July 2023, providing a favorable comparison in 2024, so fluctuations can occur monthly.

Tony Staniak, CFO

Yes, and to add, if there are any weaknesses, it could stem from the responses in the previous questions regarding CPG impacting more on its packaging in the quarter. So that’s playing a role as well.

Barton Crockett, Analyst

Okay. Now, regarding the sale of the majority of your European operations, is there any size indication you can provide regarding cash flow impact? Europe overall is about 5% of revenues, I assume that's the majority, but some more context would be beneficial.

Tony Staniak, CFO

Certainly. To clarify, we refer to the majority of the European operations sale. We are retaining a very important shared services center in Poland, which consists of 400 employees supporting our U.S. admin operations and clients. The revenue-generating operations comprising 5% of total revenues is what we're selling to Capmont in this transaction. When you consider the typical print EBITDA multiples for this enterprise value, you can gauge the approximate EBITDA range. Additionally, having a lower debt leverage ratio enhances our ability to reduce debt using these proceeds.

Barton Crockett, Analyst

Okay, so you mentioned the leverage range is half of the EBITDA multiple? Did I hear that correctly?

Tony Staniak, CFO

Yes, that is correct. The leverage ratio is around 2.16 times and that average is approximately half of typical print multiples.

Barton Crockett, Analyst

Understood. As for the outlook for early next year, given that you're slowing down in Q4, are you sensing anything better about next year? Or is it too soon to project? Any insights on next year's revenue trajectory?

Joel Quadracci, Chairman, President and CEO

I'd say it's probably too early to tell because our clients are still in their busy season. While we gather some early indications, we don't anticipate any substantial insights until we approach year-end and they begin their planning cycle.

Barton Crockett, Analyst

Okay. You’ve also stated asset sales of approximately $113.7 million thus far. However, your statement of cash flow shows proceeds from asset sales at around $46 million. I understand that Europe’s Tacoma may be part of that, but can you provide clarity on what else is included? Additionally, are there other potential sales pending that could increase this number either this year or next year?

Tony Staniak, CFO

Sure, I can clarify that. For the cash flow statement, there are line items that contribute to our total proceeds. You correctly noted the asset sales of $40 million, primarily from the Saratoga sale in Q3, while an additional $22 million was from the sale of our Manipal investment in India earlier in the year. These two line items bridge the gap to the $114 million total. As for additional assets, we are currently listing various buildings for sale, but I don’t foresee any sales this year, so those would be more likely to close in 2025.

Barton Crockett, Analyst

Thank you. Lastly, regarding the $60 million in savings discussed, is that a realized figure for this year, or does it represent an annualized figure as we exit next year?

Joel Quadracci, Chairman, President and CEO

It’s a realized figure to answer that part of the question.

Barton Crockett, Analyst

What would be the annualized rate from that?

Joel Quadracci, Chairman, President and CEO

So if $60 million is realized, some tailwind could occur in 2025 as we had some remaining personnel costs in the first half of the year due to the plant closures. So you might see an incremental benefit of $15 to $20 million as we head into 2025.

Barton Crockett, Analyst

Understood. On the topic of your debt reduction, you updated terms one more time. How should we consider the trajectory of your interest expenses moving forward?

Joel Quadracci, Chairman, President and CEO

Yes. With the new debt deal, the spread on that increased by 50 basis points. However, we expect that variable interest rates will decline, along with the interest rate on this variable-rate debt. The efforts we made to lower our leverage could see our interest rates stabilize around 7% in the near future, all while managing a lower debt load, so interest costs should decrease significantly.

Barton Crockett, Analyst

Thank you. Finally, backtracking to the Google AI arrangement, when do you expect it to start making a significant impact on your business?

Joel Quadracci, Chairman, President and CEO

We expect to roll it out in a live format towards the end of the year, with more comprehensive implementation occurring throughout next year. It will enhance our overall customer experience because once we identify the audience, we anticipate that this will lead to increased business across all services.

Barton Crockett, Analyst

Okay, great. That's all from me. Thank you.

Tony Staniak, CFO

Thanks, Barton.

Joel Quadracci, Chairman, President and CEO

Thanks, Barton. Operator?

Operator, Operator

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

Joel Quadracci, Chairman, President and CEO

All right, well, thanks everyone for joining today's call. I want to close by reiterating that our integrated marketing offering continues to be a competitive differentiator and key driver behind our ongoing evolution as an MX company. By providing a better experience for our clients, they can focus on enhancing the customer experience for their end users. I’d like to remind investors of our November 20 Investor Day in New York City, where you can learn more about the MX experience. With that, thank you again and have a great day.

Operator, Operator

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