Earnings Call Transcript - QUAD Q2 2023

Operator, Operator

Good morning, and welcome to Quad's second quarter conference call. 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. Please note, this event is being recorded. I would now like to 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 second quarter and year-to-date 2023 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, Katie, and good morning, everyone. Beginning on Slide 3, our second quarter 2023 results were in line with our expectations. Net sales were lower in the quarter compared to the same period in 2022, primarily due to lower paper and print sales as well as the 2022 divestiture of our Argentina print operations. We are pleased to have generated $34 million of free cash flow in the quarter, which we have used to further pay down debt, strengthen our balance sheet and return value to shareholders through additional share repurchases. We are reaffirming our full year 2023 financial guidance. While some marketers have reduced print volumes due to economic uncertainty and postage rate increases, we continue to innovate solutions to help clients better manage costs, including our industry differentiating postage savings programs. For example, our unique merged mail solution combines multiple marketers' direct mail piece production into a single run delivering postage savings while maintaining content personalization. Our door front direct solution provides an innovative alternative to U.S. postal service delivery, bypassing the mailbox and delivering magazines, catalogs, direct mail and retail pieces directly to recipients' front doors. Our clients always depend on our quality, on-time performance, and we have the right platform and expanded capabilities to fulfill our clients' print media and marketing needs as we enter the seasonally busier back half of the year. As always, and especially in the current economic environment, we continue our long-standing disciplined approach to managing all aspects of our business, including treating all costs as variable and aligning our cost structure to revenue opportunities. At the same time, we continue to advance our unique offering as a marketing experience (MX) company that brings together all the resources brands need for frictionless execution, as shown on Slide 4. Further, our integrated marketing platform easily supports shifts in our clients' marketing spend to maximize growth and results. On Slide 5, we show Quad's three growth drivers; delivering integrated service excellence, accelerating market penetration, and evolving our culture as an MX company. Integrated service excellence is at the core of who we are and what we do. Quad connects every facet of the marketing journey efficiently and at scale, providing innovative, data-driven offerings from strategy and consulting to data and analytics, technology solutions, media services, creative and content solutions, and managed services. As a result, we help companies reduce the complexities they experience from working with multiple agency partners and vendors, increase their marketing process efficiency, and maximize the effectiveness of their marketing efforts. We are continuing our partnership with Forrester Research, a leading global research advisory firm, to better understand the demand for holistic marketing solutions at a time of accelerating marketing complexity, dwindling budgets, and rising customer expectations of brands. Through its survey of 355 marketing decision-makers at mid- to large-sized U.S. companies, Forrester confirmed and quantified brands' ongoing need to deliver growth with even fewer resources and greater results. While 75% of brands have started consolidating some services, their efforts are keeping pace with the expanded complexity, resulting in disconnected teams and workflows, wasted time and money, and missed customer opportunities. Forrester's findings further validate our multiyear transformation to an MX company that makes the marketer's job easier through an efficient and effective platform built for integrated execution. Turning to Slide 6, we continue to evolve how we communicate our value. To accelerate market penetration, we launched a new brand campaign in the second quarter called Built on Quad, which is giving us wider visibility within our current client base as well as with companies in our targeted growth verticals. We debuted the campaign in June in conjunction with the Cannes Lions International Festival of Creativity, the premier gathering of the global advertising and creative communications industry. While we were at Cannes, we shared our innovative story and strengthened relationships with marketing decision-makers from around the world who are looking for scalable solutions to help drive their brands' growth. Our uniqueness as an MX company resonates with brands and marketers because we provide a better marketing experience for our clients, allowing them to focus on delivering the best customer experience. Turning to Slide 7, we show how we are growing our presence with well-known brands and our targeted verticals of consumer packaged goods, finance and insurance, health, direct-to-consumer, retail, and publishing. These well-respected and well-known brands include Red Bull, Sirius XM, Albertsons, and CVS Health, all admired for the excellence in the loyalty they have built with our customers. We take great pride in knowing they trust us to help unlock their marketing's full potential. On Slide 8, we show an example of how a consumer packaged goods company, Nielsen-Massey Vanillas, is taking advantage of our integrated marketing offering. They chose to partner with Quad due to our great reputation for delivering breakthrough creative and brand growth in saturated markets, especially in CPG categories, along with our robust data, insights, and media capabilities. As the creative agency of record, we are now providing brand strategy, creative and campaign development, media, social, and more to build awareness and loyalty among home cooks as well as professional chefs. We're also helping the client to reach its most compatible customers through our award-winning cross-channel shopper targeting approach as well as managing media planning and buying. Work for Nielsen-Massey Vanillas is underway and will be launched in the fourth quarter of this year. This is yet another example of how we are creating a better way for our clients through a reimagined marketing experience that is more streamlined, impactful, flexible, and frictionless. On Slide 9, we show another example of how we help clients build better marketing, in this instance, how we created a consumer brand from inception, including a product launch at select Costco Warehouse stores this summer. Our client created an innovative freeze-dried raw superfood for dogs. We not only helped our client position and name its brand Heckova!, but used the power of our integrated solutions offering to deliver eye-catching packaging and promotion. We drew on our deep expertise in consumer research, design strategy, packaging, experiential and adaptive design, content services, and retail environments. We also seamlessly incorporated the services of our own photo studios, including digital creatives, designing and printing the packaging and the in-store look for the product, standing up an appealing and interactive website, and providing comprehensive marketing services, including promotional campaigns for digital and social channels and engaging social media influencers. The client is thrilled with our efforts and the speed and ease with which we helped them launch a brand. In fact, our client told us numerous times that they never could have gotten the product launched, set on store shelves, and promoted in the span of 10 months had they not worked with Quad. We continue to be a trusted partner to Heckova!, supporting their efforts to launch additional superfoods and providing campaign work as they expand the retail footprint and begin direct-to-consumer sales this fall. The client will also engage our package insight team for brand package performance research using the latest biometric technology such as Mobile Eye Tracking. Turning to Slide 10, even as we expand into growing areas of the marketing experience, printing continues to be a core part of our business and a clear competitive differentiator from traditional agencies. Our reputation for quality, on-time production, ongoing investments in automation and equipment, and a well-trained skilled workforce enable us to continue to gain segment share across all categories of print. Recently, we expanded our print relationship with AARP, the organization that delivers information, advocacy, and service to people age 50 and over. Under a new multiyear contract, we are now the exclusive printer of the AARP Bulletin and AARP Magazine, two of the largest circulation publications in the United States. For years, AARP has trusted Quad for production of its direct mail advocacy program, along with our posted saving, co-mingling services, and logistics expertise. We will begin production on these two publications in August and September, respectively. Additionally, AARP has engaged us for our pre-press services, including page processing and proofing, image retouching and archiving, ad traffic management, mailing list management, and distribution to U.S. coastal service processing facilities for expedited in-home delivery. AARP will also leverage two of our proprietary Software-as-a-Service workflow solutions, Publisher's Studio for issue mapping and AdShuttle for streamlining the planning, receipt, and execution of advertising. Our excellent track record with this client's direct marketing campaigns, combined with our commitment to continuous innovation and our industry standing as a strong, stable provider cemented this client expansion win. Before I turn the call over to Tony, I would like to thank our employees for their continued hard work and daily commitment to providing the highest levels of service for our clients while we proactively manage all aspects of our business for long-term strength and stability. I regularly receive feedback from clients who share their deep appreciation for our team of innovators and problem solvers. As we move forward with our growth strategy, I have great confidence in our team. We will continue to capitalize on all aspects of our distinctive maker culture to differentiate Quad as the workplace for the marketing industry's best talent. We also will continue to innovate the ways we attract talent. For example, last month, we unveiled a new recruiting and training hub in Milwaukee Central City as shown on Slide 11. This hub, known as Quad MKE, is focused on removing barriers to family-sustaining careers by providing the tools, training, and transportation necessary to attract individuals looking to improve their employment situation. Quad MKE is an important way to tangibly show our commitment to the community and is consistent with our values, especially that of believing in people. With that, I will now turn over the call to Tony for the financial review.

Tony Staniak, CFO

Thanks, Joel, and good morning, everyone. On Slide 12, we show a diverse revenue mix. Net sales were $703 million in the second quarter of 2023, a 7% decline compared to the second quarter of 2022. For the first half of 2023, net sales were $1.5 billion, a decline of 2% compared to the first half of 2022, well within our financial guidance with sales growth in our Mexico operations and in our catalog, packaging, and in-store offerings being more than offset by lower print and paper sales, primarily in direct mail, as well as reduced sales from the December 2022 divestiture of our Argentina operations. Slide 13 provides a snapshot of our second quarter 2023 financial results. Adjusted EBITDA was $50 million in the second quarter of 2023 as compared to $56 million in the second quarter of 2022, and adjusted EBITDA margin declined slightly to 7.2% in the second quarter of 2023 compared to 7.4% in the second quarter of 2022. The decline was due to lower sales, partially offset by benefits from improved manufacturing productivity and savings from cost reduction initiatives. In the first half of 2023, adjusted EBITDA was $111 million compared to $105 million in the first half of 2022, and adjusted EBITDA margin improved from 7.0% to 7.5%, consistent with our long-term focus on increasing profitability. Adjusted diluted earnings per share was $0.02 in the second quarter of 2023 as compared to $0.13 in the second quarter of 2022. Year-to-date, adjusted diluted earnings per share was consistent at $0.17. The decline in the second quarter was primarily due to lower adjusted net earnings, partially offset by the positive impact from share repurchases. We were active in the market again this quarter, repurchasing our Class A shares. Beginning in the second quarter of 2022, we have repurchased approximately 8% of our total Class A and B outstanding common stock at a weighted average price of $3.32 per share for a total purchase price of $15 million. Free cash flow was negative $45 million in the first half of 2023, which is a $12 million improvement compared to the first half of 2022, primarily attributable to lower inventory needs as supply chain challenges improved and we experienced strong receivables collections. This improvement was achieved despite a $12 million increase in capital expenditures as we continue to invest in our automation initiatives. As a reminder, the company historically generates the majority of its free cash flow in the fourth quarter of the year and expects $50 million to $90 million of free cash flow in 2023. Slide 14 includes a summary of our debt capital structure. Net debt increased by $59 million to $604 million at June 30, 2023, compared to $545 million at December 31, 2022, and the debt leverage ratio increased 18 basis points to 2.34x at the end of the second quarter of 2023. The increase in net debt and the debt leverage ratio was primarily due to the negative $45 million of free cash flow in the first half of 2023. However, we are pleased to have reduced debt by $80 million over the last 12 months, and that will increase in the third quarter due to higher working capital requirements as we enter our production peak from August through October, and then it will decline in the fourth quarter with seasonal reduction of inventory and collections of receivables. We are on track to achieve the low end of our long-term targeted debt leverage range of 2x to 2.5x by the end of 2023. As of June 30, our blended interest rate was 6.7%, which is up from 3.8% a year ago. To mitigate the impact of the rising interest rate environment, we entered into two interest rate collar agreements effective February 1, 2023, including interest rate swaps. Our debt is 52% floating and 48% fixed. We maintained our strong liquidity with up to $340 million of availability under our revolving credit agreement as well as $11 million of cash on hand. Our nearest significant debt maturity is $88 million occurring in January 2024, which we will fund with cash on hand and our revolving credit agreement. The majority of the debt maturities are not due until late 2026. We have reaffirmed our 2023 guidance, as shown on Slide 15. We are progressing on our growth strategy as clients continue to embrace our innovative and integrated marketing offering. However, as we discussed last quarter, due to ongoing macroeconomic concerns and increasing postage rates, we expect lower print volumes during the remainder of the year. As a reminder, adjusted EBITDA and free cash flow will be higher in the second half of 2023 compared to the first half of 2023 due to the seasonality of the business. Most of our capital expenditures already occurred in the first half of this year, so we can benefit from these investments in the second half of the year during our seasonal peak. Slide 16 includes our key investment highlights as we continue to build on our growth 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, there is a significant addressable revenue opportunity with both our large base of existing clients as well as new clients. We will reduce debt with strong free cash flow generation augmented with proceeds from selling non-client assets. We expect to achieve the low end of our long-term targeted leverage range of 2x to 2.5x with net debt of approximately $470 million by the end of the year. This will represent a $564 million or 55% reduction in debt since January 1, 2020, when our debt was over $1 billion. With the significant debt reduction, we will further strengthen what we believe is an industry-leading financial foundation that provides us the flexibility to strategically deploy capital, including scaling the growing parts of our business while returning capital to shareholders to drive shareholder value. With that, I'd like to turn the call back to our operator for questions.

Operator, Operator

The first question comes from Kevin Steinke with Barrington Research Associates.

Kevin Steinke, Analyst

I wanted to start off by asking about just the seasonal pattern of sales as it relates to the second quarter and then also how you expect the second half to play out? And maybe how any segment share gains or new business wins might play into your outlook for the second half of the year?

Joel Quadracci, Chairman, President, and CEO

Sure, Kevin. I think as we put out guidance earlier in the year, we had seen that our customers, as they put forth their budgets, had some trepidation about economic concerns. Additionally, a known significant postal increase that just happened a couple of weeks ago also somewhat impacted volumes for the year. Oftentimes, our clients look at that and in the short term, they may do a little bit of pullback. That being said, I'd say we always talk about large-scale print, which encompasses retail inserts and publications, as our biggest declining area. Year-to-date, that was virtually flat, showing significant challenges in retail insurance, as we always expect, along with some closures in the publication side. But we also saw offsetting segment share gains in targeted print, encompassing direct mail, packaging, and in-store solutions. Direct mail has indeed faced more challenges, down about 19% year-to-date, primarily due to significant exposure in the financial and loan vertical, heavily impacted by drastic increases in interest rates, as well as a large banking client pulling out of consumer banking. However, we expect direct mail to continue to be a great growth opportunity in the long term. On the bright side, packaging was up 4% year-to-date, and in-store saw growth as well, maintaining an upward trend. It's essential to remember that the first half of the year represents the lowest part of our sales cycle, with the second quarter being at the bottom, while we are now entering our busy season. We anticipate segment share gains coming in the near future, such as those discussed with AARP, which certainly helps fortify our outlook. Overall, we feel confident about our guidance.

Tony Staniak, CFO

No. I think if I were to add onto Joel's insights about earnings slightly, we have been taking actions in the first half of the year, which include restructuring actions to ensure that our cost structure aligns with business needs. Capital expenditures from a cash perspective have largely been made in the first half of the year, positioning us well for a strong second half as volumes increase.

Kevin Steinke, Analyst

Okay. Great. That's very helpful. And Tony, you mentioned the cost actions. Can you just speak to what you've accomplished in the first half of the year here? And maybe how we should think about expenses trending in the second half of the year?

Tony Staniak, CFO

We did close some capacity in the first half. I think we announced three plant closures that we completed in the first half of the year. This puts our capacity right where we needed it as we enter the busy season to sustain on-time deliveries and meet customer needs. We consistently assess our administrative operations to ensure efficiency and remain a low-cost provider. Overall, this positions us well for the second half, and the majority of our cash payments related to restructuring occurred in the first half of the year. You will see less of that expense as we move into the second half, positively impacting free cash flow.

Joel Quadracci, Chairman, President, and CEO

Adding to that, from a manufacturing perspective, the productivity we have achieved has been substantial this year. While the labor market previously posed challenges, we focused on recruitment and advanced training, which resulted in our team being well-prepared. This advantage plays a significant role as we ramp up in the second half, providing us with greater operating leverage and efficiency compared to past periods where we struggled to train staff on complex equipment.

Kevin Steinke, Analyst

Okay. Great. You did mention the postage rate increases as an additional factor leading to some pullback in print spend. But you also alluded to the fact that that's usually a short-term impact. So would you expect clients to adjust to that over time? And you also mentioned your solution to bypass the U.S. Postal Service. Is that something that can gain more traction going forward as well?

Joel Quadracci, Chairman, President, and CEO

Yes. Remember that postage now constitutes over 70% of the costs involved in delivering mail to consumers. We wish the pricing strategies of postal services were different, but that has been their direction. It's crucial for printers like us to help offset those increases through work-sharing programs. The more we can bypass the postal service, the more significant the discounts available. Our innovative products and solutions are helping our clients manage these costs long-term. Although they may pull back in the short term, marketing is still essential for them. Typically, clients attempt to allocate their budgets to overcome increased expenses. Our goal is to aid them with innovation to offset declines, and we are confident in our ability to assist them, even as postage increases will remain a concern.

Kevin Steinke, Analyst

Okay. Understood. Can you just speak to the progress you made in the quarter on inventory reduction and free cash flow generation? You had $34 million of free cash flow in the second quarter, which was really a significant uptick over the year-ago quarter. Could you elaborate on that?

Tony Staniak, CFO

Yes. Thanks, Kevin. We were pleased with the free cash flow generated in the second quarter, achieving a positive $34 million, marking a significant improvement from last year. We were able to reduce inventory levels as the supply chain environment improved again, allowing us to keep inventory levels appropriate to take advantage of positive free cash flow. Additionally, we have focused on enhancing receivables collections, which is reflected positively in our free cash flow.

Kevin Steinke, Analyst

Okay. I'll ask one last one here and then jump back in the queue. But can you speak to your priorities regarding capital allocation? You continue to effectively reduce leverage year-over-year, and you're also starting to buy back shares. How do you see the mix? I know you have a target of 2.0 leverage by the end of the year. Do you expect to continue looking for opportunities to repurchase shares as well?

Joel Quadracci, Chairman, President, and CEO

Yes. This has long been a strategy for us; being disciplined with capital allocation has always been a priority. Since 2019, we have focused on debt repayment, which we've achieved substantially despite the pandemic impacting the world. We're proud of this accomplishment because we did it while appropriately investing in our print platform and innovation. With our current trajectory, I felt comfortable initiating stock buybacks this year, which we began last year. We've repurchased about 8% of the company at what we believe is a favorable price, and we will continue to evaluate these opportunities. Ultimately, we would love to look into the possibility of introducing a sustainable dividend, but that will be subject to our Board's review at the year-end, as we do annually. We will remain disciplined in our approach while we transform our company and scale our operations.

Operator, Operator

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

Joel Quadracci, Chairman, President, and CEO

Great. Thank you, operator, and thank you, everyone, for joining today's call. I just want to close by reiterating my confidence in the team, our strategy, and our future as a marketing experience company. Our integrated marketing offering continues to be a competitive differentiator and a key driver behind our company's overall organic growth. At the same time, we'll continue to manage for the times, both financially and as well as creating shareholder value. And so with that, thank you again. Have a good day. We'll look forward to speaking to you again next quarter.

Operator, Operator

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