Quad/Graphics, Inc. (NYSE:QUAD) Q3 2023 Earnings Call Transcript

Quad/Graphics, Inc. (NYSE:QUAD) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good morning, and welcome to the Quad’s third quarter conference call. [Operator Instructions] A slide presentation accompanies today’s webcast and participants are invited to follow along, advancing the slides themselves. To access the webcast, follow 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. [Operator Instructions]. Please note, that this event is being recorded. I’d like to turn the conference over to Katie Krebsbach, Quad’s Investor Relations Manager. Katie, please go ahead.

Katie Krebsbach: 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 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.

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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: Thank you, Katie, and good morning, everyone. Beginning on Slide 3. In the third quarter, we were pleased to deliver consistent year-over-year EBITDA margins and $27 million of free cash flow despite a challenging revenue environment. Net sales declined compared to the same period in 2022, primarily due to lower print, paper logistics sales as well as the 2022 divestiture of our Argentinian print operations. We continue to pay down debt, strengthen our balance sheet and return capital to shareholders through additional share repurchases. We are on track to achieve full year 2023 guidance for adjusted EBITDA, free cash flow and debt leverage. And by the end of the year, we will have reduced debt by over $560 million or 55% since January 1, 2020.

We are lowering our full year 2023 net sales guidance due to industry-wide print volume reductions in response to ongoing economic uncertainty, continued postal rate increases and the impact of rising interest rates on specific clients. At Quad, we have seen the greatest impact to categories most sensitive to rising interest rates, such as financial services, direct mail, including credit cards, insurance and loans. Tony will share more detail on our year-to-date net sales breakdown and financial guidance shortly. We are confident in our ability to manage for these near-term print volume challenges, along with long-term expected organic declines in certain product lines like retail inserts, due to 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 build momentum as a marketing experience company, and Quad is unparalleled in that we seamlessly bring together all these central resources, brands and marketers needed for frictionless, scalable marketing execution, as shown on Slide 4. As we continue to scale our integrated marketing offering, print remains a core component of our business and the largest portion of our revenue mix. We will continue to innovate and invest in print and other channels to ensure we can fulfill our clients at our expanding marketing needs. Turning to Slide 5. I’m pleased to share that we continue to evolve our strategic leadership at the governance level with the recent appointment of Melanie Huet to Quad’s Board of Directors as an independent member.

Melanie has a deep background in brand development, management and transformation and understands firsthand the challenges facing our clients. Currently, she is President of Brand Management & Innovation and a member of the Executive Committee at Newell Brands, a leading consumer products company. Prior to joining Newell in February of this year, she was Executive Vice President and Chief Commerce Officer at Serta Simmons Bedding. There, she delivered 3 quarters of market share growth, transform the sales organization and built a $1.5 billion innovation pipeline. Melanie has also worked in consumer products marketing at ConAgra Foods, Unilever, Kimberly-Clark and KraftHeinz. We look forward to leveraging Melanie’s expertise on our board as we expand and strengthen our offerings and drive revenue growth.

I’m also pleased to share that Joshua Lowcock, has joined our company as President of Quad Media and will further energize our efforts to create a differentiated, cohesive and market-leading audience targeting and media engagement offering. Joshua joins us from UM Worldwide, part of agency holding company, IPG, where he was Global Chief Media Officer responsible for omnichannel media, strategy, predictive analytics, performance marketing, content, innovation and ad tech. He played a pivotal role in developing involving UM Worldwide’s go-to-market strategy. Previously, Joshua worked at Mediavest, where he led the Walmart digital team. He also served as Head of Commercial Products and Platforms at News Corp where he led the launch of the company’s customer data and analytics strategy.

Joshua is well known in the industry and publishes and speaks regularly on topics relating to media, innovation and transformation. We will tap his considerable experience and expertise to elevate relationships with clients and fast track growth in areas that represent significant opportunity for us. On Slide 6, we show Quad’s key growth drivers, delivering integrated service excellence, accelerating market penetration in key verticals 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 complexity they experience from working with multiple agency partners and vendors, increase their marketing process efficiency and maximize the effectiveness of their marketing efforts. Turning to Slide 7. We show how we are growing our presence with well-known brands in our target verticals of consumer packaged goods, finance and insurance, health, direct-to-consumer, retail and publishing. These reputable well-known brands include Amazon, Walmart, Conagra, American Express and Abbott Labs, and are all admired for the excellence in the loyalty they have built with consumers. We take great pride in knowing they trust us to deliver on their marketing vision. To accelerate market penetration, we are focused on growing awareness that better marketing is built on Quad.

We are gaining visibility with new brands, including blue-chip companies through our participation in industry events. For example, we recently participated in the 2023 Forbes CMO Summit, Miami and Advertising Week in New York City, where we connected with brands and marketers about their marketing challenges and how Quad can solve those challenges. On Slide 8, we show an example of how we’re growing momentum with a premier brand, Titleist, the golf industry’s leading performance equipment brand, recently engaged us for our brand design and product launch expertise. We will be updating the packaging for its flagship Pro V1 golf ball, the most played ball in PGA TOUR and the #1 golf ball brand in the world. This opportunity represents significant positive exposure for Quad as the Titleist company produces more than 350 million golf balls every year.

Titleist selected Quad for several reasons, including our exceptional approach to brand design in which we focus on making brands a favor through measured potential, consumer action and reaction and connections, our comprehensive creative services and expertise, which include brand positioning, design strategy, brand identity systems, adaptive design, packaging and retail environment. Our ability to leverage our own in-house consumer testing for brand package performance by our package insight team and our proven product launch expertise, which consists of our strategy, creative and connections planning to build in place attention grabbing campaigns that bolster awareness and drive sales. We are excited to be under a multiyear contract as Titleist trusted partner for this high-profile brand building work, which will be in market in early 2025.

We successfully competed against respected sports brand agencies with deep category experience for this win. We look forward to expanding our partnership with Titleist parent company, Acushnet for other top-rated equipment for golfers. On Slide 9, we show an example of how we’re helping another thriving consumer packaged goods company achieved brand growth. Cacique, the #1 producer of authentic Mexican-style cheeses, meats, sopes and other products in the U.S. is experiencing rapid growth as demand for Hispanic foods soar. Cacique chose to partner with Quad due to our reputation for delivering breakthrough creative and brand growth in CPG categories. The company came to us by a word of mouth, recommended by another client for whom we are providing brand strategy, creative and campaign development and more.

As Cacique’s new creative agency of record, we are focused on building awareness and loyalty among consumers seeking authentic ingredients and high-quality products in this category. In addition to brand strategy and creative and campaign development, we are also leveraging our data-driven connections, planning expertise in support of Cacique’s aggressive business goals to reach new market segments. Our work with Cacique is just underway and will be in the market in 2024. Cacique is an impressive brand new to our CPG portfolio and one with tremendous revenue growth opportunity. Already, we are in discussions with this client for more opportunities to refresh its brand and packaging and provide printing services. Turning to Slide 10. For more than 50 years, our commitment to creating a better way has inspired creativity in how we address environmental, social and governance matters.

For Quad, ESG is a business imperative as it underpins our growth strategy. We have made progress on our ESG commitments published in our inaugural 2021 report. These include maintaining our focus on diversity, equity, inclusion; prioritizing sustainable resource consumption; and investing in employee safety, health and wellness. To learn more about our commitments and how we continue to create positive, sustainable change in our company and in the communities where we live and work, please access our newly released 2023 ESG update on quad.com or scan the flowcode on Slide 10 of today’s presentation. Before I turn the call over to Tony, I would like to thank our employees during our seasonally busiest time of the year for their continued hard work and daily commitment to providing the highest levels of service for our clients.

As we move forward with our growth strategy, I have great confidence in our team and continue to be enthusiastic about our growth opportunities as a marketing experience company. With that, I will now turn the call over to Tony for the financial review.

Anthony Staniak: Thanks, Joel, and good morning, everyone. On Slide 11, we show our diverse revenue mix. Net sales were $700 million in the third quarter of 2023, a 16% decline compared to the third quarter of 2022. On a year-to-date basis, net sales were $2.2 billion in 2023, a decline of 7% compared to 2022. Our net sales were impacted by industry-wide print volume reductions in response to continued economic uncertainty, postal rate increases and the impact of rising interest rates on specific clients. For example, on a year-to-date basis, direct mail has temporarily decreased from 14% of our total revenues to 11%. We expect direct mail growth in future years. Despite these headwinds, we have seen year-to-date increases in our net sales mix from segment share gains in magazines and catalogs, in Mexico due to increased education [Technical Difficulty] volumes exported to the United States and in our in-store signage product offering, continuing a multiyear trend of high revenue growth for our in-store team.

Slide 12 provides a snapshot of our third quarter 2023 financial results. Adjusted EBITDA was $57 million in the third quarter of 2023 as compared to $69 million in the third quarter of 2022 and adjusted EBITDA margin declined slightly to 8.2% in the third quarter of 2023 compared to 8.3% in the third quarter of 2022. The decline was due to lower sales and lower pension income, partially offset by benefits from improved manufacturing productivity and savings from cost reduction initiatives. On a year-to-date basis, adjusted EBITDA was $168 million in 2023 compared to $173 million in 2022, while adjusted EBITDA margin improved from 7.4% to 7.7%. Adjusted diluted earnings per share was $0.11 in the third quarter of 2023 as compared to $0.32 in the third quarter of 2022.

On a year-to-date basis, adjusted diluted earnings per share was $0.28 in 2023 compared to $0.49 in 2022. The decline was primarily due to lower adjusted net earnings and was partially offset by the positive impact from share repurchases. We are active in the market yet again this quarter, repurchasing our Class A shares. Beginning in the second quarter of 2022, we have repurchased 5.5 million shares or approximately 10% of our outstanding shares for a total purchase price of $20 million. Free cash flow was negative $18 million in the first 9 months of 2023, a $61 million improvement compared to the first 9 months of 2022 and included $27 million of free cash flow generation in the third quarter of 2023. We have now generated positive free cash flow during both the second and third quarters of 2023, which are typically negative free cash flow quarters due to seasonality.

The increase in free cash flow was primarily attributable to lower inventory yields as supply chain challenges improved, and we experienced strong receivables collections. This improvement was achieved despite a $10 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. Slide 13 includes a summary of our debt capital structure. We are pleased to have reduced debt by $132 million over the last 12 months with strong free cash flow. However, due to the working capital build during our peak production season, on a year-to-date basis, net debt increased by $39 million to $584 million at September 30, 2023, and the debt leverage ratio increased 20 basis points to 2.36x at the end of the third quarter 2023.

The increase in net debt and the debt leverage ratio was primarily due to the negative $18 million of free cash flow and $10 million of Quad share buybacks in the first 9 months of 2023. We expect debt to decrease to under $470 million in the fourth quarter with seasonal reduction of inventory and collections of receivables, and we remain on track to achieve the low end of our long-term targeted debt leverage range of 2 to 2.5x by the end of this year. As of September 30, our blended interest rate was 7.1%, which is up from 5.7% a year ago. To mitigate the impact of the rising interest rate environment, we entered into 2 interest rate collar agreements effective February 1, 2023. Including interest rate swaps, our debt is 50% floating and 50% fixed.

Our liquidity includes up to $331 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 our revolving credit agreement and cash on hand. The majority of the debt maturities are not due until November 2026. We have updated our 2023 guidance as shown on Slide 14. Annual net sales are now expected to decline 7% to 9% compared to previous guidance of annual net sales remaining flat to declining 5%. Although we plan for organic print decline in our original guidance, print volumes fell further than our projections due to continued economic uncertainty and higher postage rates in addition to the impact on specific clients of rising interest rates, as we previously discussed.

Despite the net sales decline, our flexible model and focus on disciplined cost management and labor productivity is enabling us to increase our expected adjusted EBITDA margin by 50 basis points at the midpoints of our updated guidance ranges. That profitability performance, combined with reduced working capital requirements from improved supply chain is driving strong free cash flow and we reaffirm the midpoint of our free cash flow guidance to be $70 million in 2023, which includes at least $70 million of investment in capital expenditures to further automate our unparalleled integrated marketing platform. And finally, we continue to expect debt leverage to be approximately 2.0x by the end of 2023. Slide 15 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 with 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. As part of a multiyear debt reduction strategy, by the end of this year, we expect to reduce debt by over $560 million from over $1 billion on January 1, 2020, representing the low end of our current long-term target debt leverage range of 2.0x. We intend to further reduce debt in 2024 with our strong free cash flow generation, augmented with proceeds from selling noncore assets. And 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, and further automating our print offerings for greater production efficiencies, while returning capital to shareholders.

With that, I’d like to turn the call back to our operator for questions.

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Q&A Session

Operator: [Operator Instructions] First question is from Kevin Steinke, Barrington Research Associates.

Kevin Steinke: I wanted to start off with something that really stood out to me here is the flexibility of your business model, as you noted. The midpoint of the sales guidance, as I calculate it for 2023 came down by about 6%, but you were able to maintain the midpoint of your adjusted EBITDA guidance. So you talked about cost management and labor productivity and things like that. But maybe just talk a little bit about what you’re able to do to adjust to quickly to maintain the profitability outlook despite the lower sales outlook and maybe any actions that you took in the quarter on the cost side?

Joel Quadracci: Yes, Kevin, I’ll take — this is Joel. I’ll take a stab at that and then Tony can fill in. But yes, I mean I’d like to say that Quad has to be very ambidextrous. We come from a disruptive industry on the print side, and at the same time, we’re building a case that could actually be a disruptor on the marketing side. And so being blessed with being in the printing industry, we’ve had to be very good at adjusting to things that get thrown at us. And so we do try and keep — have a mentality that all costs are variable. And so over time, as we’ve seen some of the expected decline in some of the areas like retail inserts or publications, we’ve been able to scale down the platform by — we’ve unfortunately closing plants to adjust for it, but then realizing the value of those plants by selling the real estate to help pay down debt.

Furthermore, I’d say one of the big significant drivers too was the great work done by the people on the floor because Tony mentioned, productivity is quite a bit up this year. And when you think about where the world was only a year or so ago with really tough environment for getting labor, we ended up putting a holistic approach on that and really accelerating a lot of our training. And so as we saw softness come into this market this year due to a lot of what’s going on in the economy, the core part of the full-time equivalents, we’re much more trained up as a group than before. And so that’s another way that we’ve done it. And you look, I guess we’re a lean enterprise group, and we always have been, and we’re able to adjust very quickly.

And I think that we always have been focused on being able to weather storms and take advantage of those, which is why we move so quickly employee cost out. I mean when the pandemic hit, we got out of panic mode within weeks when that happened that spring, so that we could continue running the business. And that was by making really tough decisions very quick and squeezing down. And so it’s kind of built in our DNA, maybe partially because of where we come from, but also because I think we’ve got a very disciplined group when it comes to making sure we adjust for these times. Tony, am I missing any?

Anthony Staniak: One thing I would just add, when we think about EBITDA, Kevin, is we’ve been focused on our pricing and making sure that we get the value that we provide to customers. So you’re seeing a benefit come through the bottom line coming from in the inflationary times we’ve been able to focus on some price increases.

Joel Quadracci: Well, and also, I think that as we provide multiple service products to people, we’re getting paid for the value of that because any time we can do more than one thing for our client, we can actually help them pull cost out through workflow analysis. And really, the more they kind of expose to us, the more we can kind of look at content and figure out where a lot of the waste is and people are willing to pay for that because their savings is much greater than the value that they are paying us.

Kevin Steinke: Okay. That’s great commentary. So when I think about the change in the sales outlook, maybe just walk us through what’s changed there? Was it primarily the direct mail piece that you highlighted? Or is it more broad-based than that? Maybe as you have in previous calls, maybe just touch on the sales trends you’re seeing across the various product categories?

Joel Quadracci: Sure. And I’d say that there’s an overarching thing on top, which is really economic softness. We started seeing that from our client, as we got towards the summer as people are looking at fall. Even though retail numbers came out recently, those weren’t adjusted for inflation. So if you look at absolute units sort of in CPG world and retail, it’s actually down. So that’s an overriding factor. But we try and break out with large-scale print, targeted print and integrated solutions. We do that to kind of show where the expected decline is, and that’s in large-scale print. And so that declined as expected. I’d say retail interest may be a little bit faster pull back just because of the economic side, but we expect that to keep declining.

In targeted print, this is the area that you mentioned, where catalogs, direct mail, packaging, in-store, these tend to really benefit from our MX strategy of the working experience company because when we’re solving some of the brand problems upstream, they tend to want to then also engage us for engaging their consumers through these different channels. And the tough one here has been direct mail. And it’s important to point that out because we don’t look at this as one that’s going to keep declining. We really focus on the highly personalized, data-driven direct mail, but we were down double-digit percent sales in that this year, and we saw that starting to materialize at the end of last year when interest rates went crazy. So things like personal lending, we were deep in financial.

We had one big outfit that was exiting Consumer Banking, which was a significant player. And so I see that the blip here in sales, we certainly have some economic overhang. But in direct mail, that’s all reversible as we continue to sell the value add that direct mail brings. In-store was up 12% because that is one of our fast-growing places in packaging hung in there relatively flat. The one that other place that is hitting us on revenue would be what the post office is doing. And when I look at targeted print, catalogs is the one that’s most affected by this. We have a post office who thinks that they can fix their problem by just increasing prices as opposed to pulling cost out, and they’ve accelerated that a bit this year with our customers getting 2 increases in 1 year.

And so in catalogs that — they get affected quickly because they could pull back on their prospecting of catalogs. And so we saw some pullback there. But I’d say that there is an overall economic pullback that we’ve seen and marketing tends to see it first. And the direct mail piece is the one that I would point to for people to understand that we see that as a manageable category that’s not about — or continue to decline.

Kevin Steinke: Okay. That’s helpful. And so when I look at the updated sales guidance, you’re still — it would still imply a nice seasonal ramp in the fourth quarter in sales. So I guess, are you expecting or seeing a fairly normal sequential ramp-up related to holidays, but just, I guess, off of a lower base?