Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

or

 

o         TRANSITION REPORT PURSURANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                        to                       

 

Commission File Number 001-34806

 

QUAD/GRAPHICS, INC.

(Exact name of Registrant as specified in its charter)

 

Wisconsin

 

39-1152983

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

N63 W23075 Highway 74, Sussex, Wisconsin 53089-2827

(Address of principal executive offices) (Zip Code)

 

(414) 566 – 6000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  (Registrant is not yet required to provide financial disclosure in an Interactive Data File Format.)  Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

Accelerated filer o

 

 

Non-accelerated filer x

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

Class

 

Outstanding as of August 12, 2010

 

 

 

Class A Common Stock

 

31,588,665

 

 

 

Class B Common Stock

 

15,005,672

 

 

 

Class C Common Stock

 

245,353

 

 

 



Table of Contents

 

QUAD/GRAPHICS, INC.

 

FORM 10-Q INDEX

 

For the Quarter Ended June 30, 2010

 

 

 

 

Page No.

 

 

 

 

PART I.

FINANCIAL INFORMATION

3

 

 

 

 

Item 1.

Financial Statements (unaudited)

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

4

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows

5

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

39

 

 

 

 

 

Item 4.

Controls and Procedures

41

 

 

 

 

PART II.

OTHER INFORMATION

42

 

 

 

 

 

Item 1A.

Risk Factors

42

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

 

 

Item 6.

Exhibits

42

 

 

 

 

 

Signatures

 

43

 

 

 

 

 

Exhibit Index

44

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.                Financial Statements (unaudited)

 

QUAD/GRAPHICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share data)

(UNAUDITED)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

 

 

 

 

 

 

 

 

Products

 

$

345.5

 

$

343.6

 

$

696.8

 

$

705.0

 

Services

 

48.8

 

45.2

 

101.1

 

99.3

 

Total net sales

 

394.3

 

388.8

 

797.9

 

804.3

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

 

 

 

 

 

 

 

Products

 

255.4

 

250.3

 

515.7

 

514.9

 

Services

 

33.8

 

31.4

 

69.9

 

69.1

 

Total cost of sales

 

289.2

 

281.7

 

585.6

 

584.0

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

49.3

 

47.4

 

96.9

 

94.0

 

Depreciation and amortization

 

48.2

 

49.0

 

97.5

 

98.1

 

Restructuring, impairment and transaction-related charges

 

31.3

 

2.5

 

37.6

 

8.7

 

Total operating expenses

 

418.0

 

380.6

 

817.6

 

784.8

 

 

 

 

 

 

 

 

 

 

 

Operating (loss) income

 

(23.7

)

8.2

 

(19.7

)

19.5

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

15.0

 

16.1

 

30.3

 

32.5

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes and equity in earnings of unconsolidated entities

 

(38.7

)

(7.9

)

(50.0

)

(13.0

)

 

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

(1.5

)

0.2

 

(1.6

)

0.8

 

 

 

 

 

 

 

 

 

 

 

Loss before equity in earnings of unconsolidated entities

 

(37.2

)

(8.1

)

(48.4

)

(13.8

)

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

1.6

 

0.9

 

4.3

 

2.1

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(35.6

)

$

(7.2

)

$

(44.1

)

$

(11.7

)

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to noncontrolling interests

 

(0.1

)

 

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to Quad/Graphics common shareholders

 

$

(35.7

)

$

(7.2

)

$

(44.2

)

$

(11.7

)

 

 

 

 

 

 

 

 

 

 

Loss per share attributable to Quad/Graphics common shareholders:

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

$

(1.27

)

$

(0.25

)

$

(1.57

)

$

(0.41

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

28.1

 

28.4

 

28.1

 

28.4

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

QUAD/GRAPHICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions)

(UNAUDITED)

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

8.8

 

$

8.9

 

Receivables, less allowances for doubtful accounts of $21.5 at June 30, 2010 and $22.4 at December 31, 2009

 

197.0

 

227.2

 

Inventories

 

106.7

 

87.3

 

Prepaid expenses and other current assets

 

6.2

 

7.4

 

Deferred income taxes

 

4.0

 

5.3

 

 

 

 

 

 

 

Total current assets

 

322.7

 

336.1

 

 

 

 

 

 

 

Property, plant and equipment—net

 

1,568.8

 

1,677.3

 

Goodwill

 

39.6

 

39.6

 

Other intangible assets—net

 

8.9

 

10.0

 

Equity method investments in unconsolidated entities

 

52.4

 

40.7

 

Other long-term assets

 

20.4

 

5.5

 

 

 

 

 

 

 

Total assets

 

$

2,012.8

 

$

2,109.2

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Accounts payable

 

$

104.0

 

$

105.0

 

Tax distributions payable

 

4.8

 

6.9

 

Accrued liabilities

 

137.9

 

144.8

 

Short-term and current portion of long-term debt

 

147.8

 

100.1

 

Current portion of capital lease obligations

 

3.9

 

7.6

 

 

 

 

 

 

 

Total current liabilities

 

398.4

 

364.4

 

 

 

 

 

 

 

Long-term debt

 

709.4

 

749.7

 

Capital lease obligations

 

15.7

 

15.8

 

Deferred income taxes

 

12.5

 

16.0

 

Other long-term liabilities

 

36.5

 

39.9

 

 

 

 

 

 

 

Total liabilities

 

1,172.5

 

1,185.8

 

 

 

 

 

 

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

 

 

 

 

Redeemable equity (Note 14)

 

50.9

 

141.5

 

 

 

 

 

 

 

Quad/Graphics common stock and other equity (Note 14)

 

 

 

 

 

Preferred stock

 

 

 

Common stock, Class A

 

0.5

 

0.4

 

Common stock, Class B

 

0.4

 

0.4

 

Common stock, Class C

 

 

 

Additional paid-in capital

 

77.4

 

77.8

 

Treasury stock, at cost

 

(304.1

)

(304.5

)

Retained earnings

 

1,039.1

 

1,011.2

 

Accumulated other comprehensive loss

 

(24.3

)

(3.7

)

 

 

 

 

 

 

Quad/Graphics common stock and other equity

 

789.0

 

781.6

 

 

 

 

 

 

 

Noncontrolling interests

 

0.4

 

0.3

 

 

 

 

 

 

 

Total common stock and other equity and noncontrolling interests

 

789.4

 

781.9

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

2,012.8

 

$

2,109.2

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4



Table of Contents

 

QUAD/GRAPHICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(UNAUDITED)

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

OPERATING ACTIVITIES

 

 

 

 

 

Net loss

 

$

(44.1

)

$

(11.7

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

97.5

 

98.1

 

Impairment charges

 

24.4

 

 

Stock-based compensation charges

 

2.5

 

2.2

 

Loss on sales or disposal of property, plant and equipment

 

0.6

 

0.1

 

Deferred income taxes

 

(1.9

)

0.2

 

Equity in earnings of unconsolidated entities

 

(4.3

)

(2.1

)

Dividends from unconsolidated entities

 

0.1

 

2.1

 

Changes in operating assets and liabilities—net of acquisitions

 

(0.5

)

(20.2

)

 

 

 

 

 

 

Net cash provided by operating activities

 

74.3

 

68.7

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

Purchases of property, plant and equipment

 

(42.5

)

(57.1

)

Proceeds from the sale of property, plant and equipment

 

0.5

 

0.1

 

Equity investment in unconsolidated entities

 

(10.0

)

 

Acquisitions of businesses, net of cash acquired

 

 

(0.6

)

 

 

 

 

 

 

Net cash used in investing activities

 

(52.0

)

(57.6

)

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

Payments of long-term debt

 

(19.7

)

(17.7

)

Payments of capital lease obligations

 

(7.1

)

(5.8

)

Borrowings on revolving credit facilities

 

217.4

 

314.7

 

Payments on revolving credit facilities

 

(175.5

)

(301.7

)

Payment of capitalized debt issuance costs

 

(13.7

)

 

Proceeds from issuance of common stock

 

0.2

 

1.1

 

Purchase of treasury stock

 

 

(5.8

)

Payment of cash dividends

 

(14.0

)

 

Payment of tax distributions

 

(9.1

)

(10.0

)

 

 

 

 

 

 

Net cash used in financing activities

 

(21.5

)

(25.2

)

 

 

 

 

 

 

Effect of exchange rates on cash and cash equivalents

 

(0.9

)

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(0.1

)

(14.1

)

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

8.9

 

18.8

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

8.8

 

$

4.7

 

 

 

 

 

 

 

SUPPLEMENTAL NON-CASH DISCLOSURE

 

 

 

 

 

Acquisition of noncontrolling interest (Note 3)

 

$

 

$

8.9

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

Note 1. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements for Quad/Graphics, Inc. and its subsidiaries (the “Company” or “Quad/Graphics”) have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such SEC rules and regulations.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated annual financial statements as of and for the year ended December 31, 2009 and notes thereto included in the Company’s Registration Statement on Form S-4/A (Registration No. 333-165259) filed with the SEC on May 26, 2010.

 

The results of operations for the three and six months ended June 30, 2010 are not necessarily indicative of the results that can be expected for the entire year ending December 31, 2010.  The financial information contained herein reflects all adjustments, in the opinion of management, necessary for a fair presentation of the Company’s results of operations for the three and six months ended June 30, 2010 and 2009.  All significant intercompany transactions have been eliminated in consolidation.  These unaudited condensed consolidated financial statements include estimates and assumptions of management that affect the amounts reported in the condensed consolidated financial statements.  Actual results could differ from these estimates.

 

On July 2, 2010, pursuant to the terms and conditions of the arrangement agreement with World Color Press Inc. (“World Color Press”) dated as of January 25, 2010, World Color Press has become a wholly-owned subsidiary of Quad/Graphics, as further discussed in Notes 3 and 17.  World Color Press’ results of operations and account balances will be included in the Company’s results of operations and balance sheet prospectively as of the July 2, 2010 transaction date.

 

Note 2. Recent Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued accounting guidance which introduces a requirement to perform ongoing assessments to determine whether an entity is a variable interest entity and whether an enterprise is the primary beneficiary of a variable interest entity.  In addition, this accounting guidance clarifies that the enterprise that is required to consolidate a variable interest entity will have a controlling financial interest evidenced by (1) the power to direct the activities that most significantly affect the entity’s economic performance and (2) the obligation to absorb losses or the right to receive benefits that are potentially significant to the variable interest entity.  Additional disclosures are required regarding involvement with variable interest entities, as well as the methodology used to determine the primary beneficiary of any variable interest entities.  The Company adopted this guidance effective January 1, 2010, and the adoption of the accounting guidance did not have an impact on the Company’s consolidated financial statements.

 

Note 3. Acquisitions

 

2010 Acquisitions

 

On January 25, 2010, Quad/Graphics and World Color Press signed a definitive arrangement agreement pursuant to which Quad/Graphics would acquire World Color Press.  On May 26, 2010, Quad/Graphics filed with the SEC the final amendment to its Registration Statement on Form S-4/A (Registration No. 333-165259) to register with the SEC its Class A common stock to be issued to the World Color Press shareholders upon consummation of the acquisition, and on May 27, 2010 the SEC declared that registration statement effective.  On June 24, 2010, the Quad/Graphics shareholders approved the transaction and on June 25, 2010, the World Color Press shareholders approved the transaction.  On June 28, 2010, the Quebec Superior Court issued the final order granting approval of the plan of arrangement under the Canada Business Corporations Act.  The acquisition was completed on July 2, 2010.  See Note 17 for events subsequent to June 30, 2010, pertaining to the consummation of the World Color Press acquisition.

 

2009 Acquisitions

 

On January 30, 2009, the Company acquired the final 32% interest in Quad/Winkowski Sp. z o.o. (“Quad/Winkowski”) to increase the Company’s ownership to 100% in exchange for fair value consideration of $8.9 million. Quad/Winkowski’s operations are included in the International segment.

 

6



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

Note 4. Restructuring, Impairment and Transaction-Related Charges

 

The Company recorded restructuring, impairment and transaction-related charges during the three and six months ended June 30, 2010 and 2009 as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Employee Terminations

 

$

1.2

 

$

2.5

 

$

1.2

 

$

8.7

 

Impairment Charges

 

24.4

 

 

24.4

 

 

Transaction-Related Charges

 

2.7

 

 

8.9

 

 

Integration Costs

 

2.2

 

 

2.2

 

 

Other Restructuring Charges

 

0.8

 

 

0.9

 

 

Total

 

$

31.3

 

$

2.5

 

$

37.6

 

$

8.7

 

 

The restructuring charges recorded are based on restructuring plans that have been committed to by management and are, in part, based upon management’s best estimates of future events.  Changes to the estimates may require future adjustments to the restructuring liabilities.  The costs related to restructuring activities have been recorded on the condensed consolidated statements of operations as restructuring, impairment and transaction-related charges.

 

On June 16, 2010, the Company announced a plant closure in Poland.  The Company began equipment relocations in July and expects to complete all moves by the end of 2010.  At that time, the plant will be permanently closed.  As part of this plant closure, the Company has recognized $1.2 million of legally required severance charges in the three and six months ended June 30, 2010 and will incur additional severance charges in the future for 707 headcount reductions.  The Company expects the majority of the restructuring related cash payments to be made within the next twelve months.

 

For the three and six months ended June 30, 2010, the company recorded: (1) $1.2 million of legally required severance for the previously discussed Poland plant closure (International segment) for both periods, (2) $24.4 million of impairment charges on assets for the Poland plant closure for both periods, (3) $2.7 million and $8.9 million, respectively, of transaction costs in connection with the acquisition of World Color Press (discussed further in Notes 3 and 17), (4) $2.2 million of integration costs in connection with the acquisition of World Color Press (discussed further in Notes 3 and 17) for both periods and (5) $0.8 million and $0.9 million, respectively, of lease termination costs related to the U.S. Print and Related Services segment.  The transaction costs and the integration costs are expensed as incurred in accordance with the applicable accounting guidance on business combinations, and are recorded within the Corporate segment.

 

For the three and six months ended June 30, 2009, the company recorded: (1) $2.4 million and $8.6 million for 166 and 716 headcount reductions, respectively, related to the U.S. Print and Related Services segment and (2) $0.1 million for 72 headcount reductions related to the International segment for both periods.

 

Activity impacting the Company’s restructuring reserve for the six months ended June 30, 2010 is as follows:

 

 

 

Employee
Terminations

 

Impairment
Charges

 

Transaction-
Related Charges

 

Integration
Costs

 

Other
Restructuring
Charges

 

Total

 

Balance at December 31, 2009

 

$

0.1

 

$

 

$

 

$

 

$

1.4

 

1.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserve provisions

 

1.2

 

24.4

 

8.9

 

2.2

 

0.9

 

37.6

 

Cash payments

 

(0.1

)

 

(7.5

)

(2.2

)

(1.2

)

(11.0

)

Non-cash write-offs

 

 

(24.4

)

 

 

 

(24.4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2010

 

$

1.2

 

$

 

$

1.4

 

$

 

$

1.1

 

$

3.7

 

 

7



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

Note 5. Goodwill and Other Intangible Assets

 

Goodwill at June 30, 2010 and December 31, 2009 was as follows:

 

 

 

U.S. Print and
Related
Services

 

International

 

Total

 

Balance at December 31, 2009

 

$

37.5

 

$

2.1

 

$

39.6

 

Acquisitions

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2010

 

$

37.5

 

$

2.1

 

$

39.6

 

 

Goodwill at June 30, 2010 and December 31, 2009 did not include any accumulated impairment losses.  Subsequent to June 30, 2010, the Company completed the acquisition of World Color Press as described further in Notes 3 and 17, and, as a result, goodwill increased in July 2010.

 

The components of other intangible assets at June 30, 2010 and December 31, 2009 were as follows:

 

 

 

June 30, 2010

 

December 31, 2009

 

 

 

Weighted
Average
Amortization
Period (Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization
and Foreign
Exchange

 

Net
Book
Value

 

Weighted
Average
Amortization
Period (Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization
and Foreign
Exchange

 

Net Book
Value

 

Finite-lived intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trademarks, patents, licenses and agreements

 

5

 

$

9.4

 

$

(8.4

)

$

1.0

 

5

 

$

10.1

 

$

(8.9

)

$

1.2

 

Capitalized software

 

5

 

4.1

 

(0.5

)

3.6

 

5

 

4.1

 

(0.1

)

4.0

 

Acquired technology

 

5

 

5.3

 

(2.2

)

3.1

 

5

 

5.3

 

(1.7

)

3.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total finite-lived intangible assets

 

 

 

18.8

 

(11.1

)

7.7

 

 

 

19.5

 

(10.7

)

8.8

 

Other indefinite-lived intangible assets

 

 

 

1.2

 

 

1.2

 

 

 

1.2

 

 

1.2

 

Total other intangible assets

 

 

 

$

20.0

 

$

(11.1

)

$

8.9

 

 

 

$

20.7

 

$

(10.7

)

$

10.0

 

 

For the six months ended June 30, 2010, the gross carrying amount of other intangible assets decreased $0.7 million as a result of foreign currency translation.  For the six months ended June 30, 2009, the Company recorded additions to intangible assets of $1.0 million primarily as a result of internally generated capitalized software.

 

Amortization expense for other intangible assets was $0.6 million and $1.2 million for the three and six months ended June 30, 2010, respectively.  Amortization expense for other intangible assets was $0.5 million and $1.0 million for the three and six months ended June 30, 2009, respectively.  The following table outlines the estimated amortization expense related to intangible assets as of June 30, 2010:

 

2010

 

$

2.5

 

2011

 

2.3

 

2012

 

2.1

 

2013

 

1.3

 

2014

 

0.7

 

Total

 

$

8.9

 

 

8



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

Note 6. Inventories

 

The components of the Company’s inventories at June 30, 2010 and December 31, 2009 were as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Raw materials and manufacturing supplies

 

$

71.1

 

$

61.3

 

Work in process

 

23.4

 

16.6

 

Finished goods

 

12.2

 

9.4

 

Total

 

$

106.7

 

$

87.3

 

 

On January 1, 2010, the Company changed its method of accounting for certain inventories from last-in, last-out (“LIFO”) method to first-in, first-out (“FIFO”).  The Company believes the change is preferable because the FIFO inventory method provides a more meaningful presentation of financial position as it reflects more recent costs in the consolidated balance sheet.  Moreover, the change also conforms all of the Company’s raw material, work in process and finished goods to a single costing method.  The impact of the inventory valuation change to FIFO did not result in a material impact on the Company’s condensed consolidated financial statements.

 

 

Note 7. Property, Plant and Equipment

 

The components of the Company’s property, plant and equipment at June 30, 2010 and December 31, 2009 were as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Land

 

$

74.4

 

$

74.2

 

Buildings

 

718.1

 

731.9

 

Machinery and equipment

 

2,777.0

 

2,821.1

 

Other

 

165.8

 

151.5

 

Construction in progress

 

24.2

 

20.1

 

 

 

3,759.5

 

3,798.8

 

Less: Accumulated depreciation

 

(2,190.7

)

(2,121.5

)

Total

 

$

1,568.8

 

$

1,677.3

 

 

Other consists of computer equipment, vehicles, furniture and fixtures and communication related equipment.  At June 30, 2010, no events or changes in circumstances indicate that the carrying value of such property, plant and equipment may not be recoverable.

 

The Company recognized depreciation expense of $47.6 million and $96.3 million for the three and six months ended June 30, 2010.  Depreciation expense of $48.5 million and $97.1 million was recorded for the three and six months ended June 30, 2009, respectively.

 

During June 2009, a fire at the Company’s West Virginia location damaged equipment and other property within the facility.  In June 2009, the Company recorded $1.1 million of selling, general and administrative expenses for the deductible payment on the related insurance claim and other non-reimbursable expenses.

 

Note 8. Equity Method Investments in Unconsolidated Entities

 

The Company has a 49% ownership interest in Plural Editora e Gráfica (“Plural”), a commercial printer based in São Paulo, Brazil.  The Company’s ownership interest in Plural is accounted for using the equity method of accounting in all periods presented.

 

9



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

The Company’s percentage of Plural’s net results of operations is recorded in the line item entitled equity in earnings of unconsolidated entities in the Company’s consolidated statements of operations, and is included within the International segment.

 

The condensed statements of operations for Plural for the three and six months ended June 30, 2010 and 2009 are presented below:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

$

23.2

 

$

17.6

 

$

46.2

 

$

33.0

 

Operating income

 

4.0

 

2.8

 

11.1

 

5.9

 

Net earnings

 

2.5

 

1.8

 

8.0

 

4.2

 

 

On February 28, 2010, the Company acquired a 47% interest in HGI Company, LLC (“HGI”), a Wisconsin-based commercial printer, for $10.0 million.  HGI specializes in short to medium-run books, manuals, directories, publications, marketing collateral and in-store/point-of-purchase materials.  HGI is accounted for using the equity method of accounting and is included within the U.S. Print and Related Services segment.

 

Note 9. Commitments and Contingencies

 

Commitments

 

The Company had firm commitments of approximately $10.0 million to purchase press and finishing equipment at June 30, 2010.

 

Litigation

 

In the normal course of business, the Company is named as a defendant in various lawsuits in which claims are asserted against the Company.  In the opinion of management, the liabilities, if any, which ultimately result from such lawsuits are not expected to have a material adverse effect on the consolidated financial statements of the Company.

 

Note 10. Debt

 

Long-term debt consists of the following as of June 30, 2010 and December 31, 2009:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Master note and security agreement

 

$

708.2

 

$

725.9

 

Revolving credit agreement — $200 million

 

68.3

 

26.5

 

Revolving credit agreement — $50 million

 

 

 

International term loan

 

67.5

 

81.9

 

International revolving credit facility

 

13.2

 

15.5

 

 

 

 

 

 

 

Total debt

 

$

857.2

 

$

849.8

 

Less: Short-term and current portion of long-term debt

 

(147.8

)

(100.1

)

 

 

 

 

 

 

Long-term debt

 

$

709.4

 

$

749.7

 

 

Based upon the interest rates available to the Company for borrowings with similar terms and maturities, the fair value of the Company’s debt was $876.4 million at June 30, 2010.

 

On April 23, 2010, Quad/Graphics entered into a $1.23 billion debt financing agreement with certain lenders consisting of a $700.0 million term loan and a $530.0 million revolving credit facility.  This debt financing agreement was entered into to fund transaction-related payments for the World Color Press acquisition, refinance Quad/Graphics’ existing revolving credit facilities and

 

10



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

refinance certain World Color Press debt obligations outstanding.  This $1.23 billion of financing is guaranteed by certain subsidiaries of Quad/Graphics and is secured by substantially all of Quad/Graphics’ and each subsidiary guarantor’s U.S. and, to a certain extent, Canadian assets, which were unencumbered prior to the date of the new debt financing agreement.  The $700.0 million term loan matures on July 1, 2016, requires variable quarterly principal payments and bears interest at a variable interest rate primarily based on LIBOR, subject to a 1.5% LIBOR minimum rate.  The $530.0 million revolving credit facility matures on the July 1, 2014 and bears interest at a variable interest rate primarily based on LIBOR.

 

This debt financing agreement subjects Quad/Graphics to certain quarterly financial covenants and also includes certain limitations on acquisitions, indebtedness, liens, dividends and repurchases of capital stock.  Pursuant to the debt financing agreement, the Company is prohibited from paying any dividends, repurchasing capital stock or making any distributions other than, among other limited situations, annual dividends or distributions not to exceed $10 million during 2010 and $60 million during each of 2011 and 2012, provided that the aggregate amount of dividends paid or distributions made does not exceed $120 million for 2010, 2011 and 2012, taken as a whole.  Starting January 1, 2013, the Company has additional dividend restrictions (based on free cash flow as defined in the debt financing agreement) if the Company’s total leverage ratio is greater than 2.75 to 1.00, but has no restrictions if the Company’s total leverage ratio is less than 2.75 to 1.00 (total leverage ratio as defined in the debt financing agreement).

 

The first borrowings under this new debt financing agreement were made subsequent to the end of the second quarter in anticipation of the July 2, 2010 consummation of the World Color Press acquisition, as further discussed in Note 17.

 

Note 11. Financial Instruments and Fair Value Measurements

 

The Company has operations in countries that have transactions outside their functional currencies and periodically enters into foreign exchange contracts.  These contracts are used to hedge the net exposures of changes in foreign currency exchange rates and are designated as either cash flow hedges or fair value hedges.  Gains or losses on net foreign currency hedges are intended to offset losses or gains on the underlying net exposures in an effort to reduce the earnings volatility resulting from fluctuating foreign currency exchange rates.

 

The Company also periodically enters into foreign exchange contracts against firm equipment purchase contracts denominated in foreign currencies and natural gas forward purchase contracts to hedge against increases in these costs.  Estimated market values were determined based upon quoted market prices.

 

GAAP defines fair value as the price that would be received for an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability.  GAAP also classifies the inputs used to measure fair value into the following hierarchy:

 

Level 1:

 

Quoted prices in active markets for identical assets or liabilities. There are no Level 1 assets or liabilities as of June 30, 2010 and December 31, 2009.

 

 

 

Level 2:

 

Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. There are no Level 2 assets or liabilities as of June 30, 2010 and December 31, 2009.

 

 

 

Level 3:

 

Unobservable inputs for the asset or liability. There are no Level 3 assets or liabilities as of June 30, 2010 and December 31, 2009.

 

The fair value of cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate their carrying values as of June 30, 2010 and December 31, 2009.

 

Note 12. Loss Per Share Attributable to Quad/Graphics Common Shareholders

 

Basic loss per share attributable to Quad/Graphics common shareholders is computed by dividing net loss attributable to Quad/Graphics common shareholders by the weighted average common shares outstanding of 28.1 million shares for the three and six months ended June 30, 2010, respectively, and 28.4 million for the three and six months ended June 30, 2009, respectively.  Diluted loss per share attributable to Quad/Graphics common shareholders includes the effect of dilutive stock options.  The Company uses the

 

11



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

treasury stock method to calculate the effect of outstanding stock options, which requires the Company to compute total proceeds as the sum of (a) the amount the employee must pay upon exercise of the award, (b) the amount of unearned stock-based compensation costs attributed to future services and (c) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award.  Stock options for which the total employee proceeds from exercise of the stock options exceed the average fair value of the same stock options over the period have an anti-dilutive effect on earnings per share, and accordingly, the Company excludes them from the calculation.  Due to the net loss attributable to Quad/Graphics common shareholders incurred during the three and six months ended June 30, 2010 and 2009, the assumed exercise of stock options was anti-dilutive and therefore not included in the diluted loss per share attributable to Quad/Graphics common shareholders calculation.

 

Reconciliations of the numerator and the denominator of the basic and diluted per share computations for the Company’s common stock are summarized as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss attributable to Quad/Graphics common shareholders

 

$

(35.7

)

$

(7.2

)

$

(44.2

)

$

(11.7

)

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average number of common shares outstanding for all classes of common shares

 

28.1

 

28.4

 

28.1

 

28.4

 

Plus: effect of dilutive stock options

 

 

 

 

 

Diluted weighted average number of common shares outstanding for all classes of common shares

 

28.1

 

28.4

 

28.1

 

28.4

 

Net loss attributable to Quad/Graphics common shareholders per share:

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

$

(1.27

)

$

(0.25

)

$

(1.57

)

$

(0.41

)

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share for all classes of common shares

 

$

 

$

 

$

0.50

 

$

 

 

Note 13. Stock Options

 

The Company has nonqualified stock option plans that allow for the granting of options to key employees and directors.  The stock options generally vest at a rate of 5% to 10% per year and expire 90 days after the respective employee’s termination from the Company.  The Company accounts for share-based compensation by measuring and recognizing compensation expense based on estimated fair values for all share-based awards.

 

As of June 30, 2010, the Company has authorized 3.8 million Class A common shares for grant in the stock option plans, and as of that date there were 24,095 shares available for future grants under the Company’s stock option plans.  On June 24, 2010, the shareholders of the Company approved the Quad/Graphics, Inc. 2010 Omnibus Incentive Plan (the “Omnibus Plan”) for two complimentary purposes: (1) to attract and retain outstanding individuals to serve as officers, directors, employees and consultants and (2) to increase shareholder value.  Contingent upon and concurrent with the July 2, 2010 closing of the World Color Press acquisition, 2.3 million shares of Class A common stock were approved for issuance under the Company’s Omnibus Plan.  Within the framework of the Omnibus Plan, a new equity-based compensation plan will be developed and implemented in the second half of 2010.

 

The Company granted 495,000 options and 395,000 options on January 1, 2010 and 2009, respectively. The grant date fair value of options was $18.78 and $16.24 per share for the grants during the six months ended June 30, 2010 and 2009, respectively, before assumed forfeitures.  The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

Expected volatility

 

27

%

23

%

Risk-free interest rate

 

3.8

%

2.3

%

Expected life (years)

 

9.8

 

9.8

 

Dividend yield

 

0.0

%

0.0

%

 

The Company determined expected volatility based on the volatility of comparable company stock.  The average risk-free interest rate is based on the United States treasury security rate in effect as of the grant date over the term of the expected life.  The

 

12



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

expected life is based on the term and vesting period of each grant adjusted for historical experience in vesting.  No dividend yield is included because dividends are credited to the option holders.

 

The Company recognizes compensation expense for stock options over the requisite service period for vesting of the award and recorded total stock-based compensation expense in selling, general and administrative expenses of $1.2 million and $2.5 million for the three and six months ended June 30, 2010, respectively.  Stock-based compensation expense of $1.1 million and $2.2 million was recorded for the three and six months ended June 30, 2009, respectively.  Total future compensation expense for all stock options granted as of June 30, 2010 is approximately $33.6 million, which is expected to be recognized over the weighted-average vesting period of 4.2 years.

 

The following table is a summary of the Company’s stock option activity for the six months ended June 30, 2010:

 

 

 

Shares Under
Option
(thousands)

 

Weighted
Average
Exercise
Price

 

Weighted Average
Remaining
Contractual Term
(years)

 

Aggregate
Intrinsic Value
(millions)

 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2009

 

3,343

 

$

17.59

 

7.6

 

$

50.9

 

Granted

 

495

 

22.50

 

9.3

 

4.3

 

Exercised

 

(11

)

4.21

 

 

 

(0.3

)

Cancelled/forfeited/expired

 

(8

)

12.25

 

 

 

(0.2

)

Outstanding at June 30, 2010

 

3,819

 

$

17.78

 

7.4

 

$

55.4

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at June 30, 2010

 

3,445

 

13.95

 

7.4

 

51.0

 

Exercisable at June 30, 2010

 

1,374

 

12.18

 

6.5

 

27.4

 

 

The intrinsic value of options exercisable and options outstanding at June 30, 2010 and December 31, 2009 is based on the fair value of the stock price.

 

Share-based compensation activity for the three and six months ended June 30, 2010 and 2009 is noted below:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Total intrinsic value of stock options exercised

 

$

0.2

 

$

0.7

 

$

0.3

 

$

5.1

 

Cash received from stock option exercises

 

$

0.1

 

$

0.8

 

$

0.2

 

$

1.1

 

Total fair value of stock options vested

 

$

 

$

 

$

5.7

 

$

5.5

 

 

Note 14. Shareholders’ Equity

 

The Company has three classes of common stock.  There are 80.0 million shares of $0.025 par value Class A common stock authorized, of which 21.3 million shares were issued at June 30, 2010 and December 31, 2009.  There are 80.0 million shares of $0.025 par value Class B common stock authorized, of which 15.0 million shares were issued at June 30, 2010 and December 31, 2009.  There are 20.0 million shares of $0.025 par value Class C common stock authorized, of which 0.5 million shares were issued at June 30, 2010 and December 31, 2009.  The Company also has 0.5 million shares of $0.01 par value preferred stock authorized, of which none have been issued at June 30, 2010 and December 31, 2009.  At June 30, 2010 and December 31, 2009, the Company had 8.5 million Class A shares, 592 Class B shares and 0.2 million Class C shares in treasury stock.

 

Per the Articles of Incorporation, dividends are paid equally for Class A, Class B and Class C common shares.  On January 2, 2010, the Board of Directors declared a $0.50 cash dividend for each share of Class A, Class B and Class C common stock outstanding to shareholders of record on January 2, 2010, which was paid on January 22, 2010.

 

From January 1, 2005 to July 1, 2010, Quad/Graphics was contractually required under a shareholders’ agreement to pay tax distributions to shareholders in connection with the Company’s election to be taxed as an S corporation.  As a result of the Company’s issuance of shares of Class A common stock pursuant to the acquisition of World Color Press, the Company’s status as an

 

13



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

S corporation terminated the day that such shares were issued and the acquisition was consummated (“Termination Date”).  As a result of the termination of the S corporation, the shareholders’ agreement was amended to terminate the obligation to pay tax distributions for periods following the Termination Date and to revise certain provisions concerning adjustments to tax distributions related to the S corporation periods prior to the Termination Date.  The shareholders during the S corporation years will receive adjusting payments if there is ultimately an increased tax liability or will be required to reimburse the Company if the tax liability decreases from what was previously estimated and distributed for such prior periods.  Adjustments could be required for: (1) the finalization of the unfiled tax years of 2009 and 2010 or (2) audits or other necessary adjustments of prior periods.  All such adjustments made after the Termination Date will be recorded to retained earnings on the consolidated balance sheet.

 

Redeemable equity

 

The Company follows the applicable GAAP and SEC authoritative guidance for redeemable stock which requires the Company to record the Class A common stock resulting from exercised stock options, vested stock options, and the Class C common stock at full redemption value at each balance sheet date to the extent the redemption of those securities is not solely within the control of the Company.

 

Under the terms of the stock option agreements, Class A common stock resulting from exercised options that are held by the employee for more than six months may be put to the Company in certain circumstances and redeemed at the then current fair value at the date of the redemption request.  Per the terms of the stock option agreements, the optionee has a put right when there is no adequate public market for the Company shares and (1) a separation of service has occurred or (2) the optionee has experienced an unforeseeable emergency.

 

Under the terms of the Articles of Incorporation, the Class C common shares are required to be owned by a qualified employee retirement plan of the Company and each holder of Class C common stock has a continuous right to have the Class C common stock repurchased by the Company.

 

Prior to January 24, 2010, under the terms of the Company profit sharing and 401(k) Plan (“Personal Enrichment Plan”), Class A common stock held in participant accounts associated with profit sharing contributions made prior to December 31, 1999 (“Pre-2000 Accounts”) could be distributed to the participant upon retirement or termination in the form of stock subject to an automatic call provision.  The Personal Enrichment Plan was amended on January 24, 2010 to change the forms of distribution for the Pre-2000 Accounts.  As a result of this Personal Enrichment Plan amendment, the Class A shares in the Pre-2000 Accounts are not required to be classified as redeemable in accordance with the applicable authoritative accounting guidance.

 

The fair value of the Company’s Class A and Class C redeemable common stock is established as of the last day of the year.  That price is adjusted throughout the following year for any dividends declared during that year, with the value reduced from the dividend declaration date forward, until year end when the fair value is adjusted to a current valuation.  The valuation methodology is based on a variety of qualitative and quantitative factors including the nature of the business and the history of the enterprise, the economic outlook in general and the condition of the specific industries in which the Company operates, the financial condition of the business, and the Company’s ability to generate free cash flow.  This determination of the fair market value employs both a comparable public company analysis, which examines the valuation multiples of companies deemed comparable, in whole or in part, to the Company, and a discounted cash flow analysis that determines a present value of the projected future cash flows of the business.  The Company regularly assesses the underlying assumptions used in the valuation methodologies.  As a result, the Company has utilized this annual fair value for all its common stock transactions, as required by the terms of all Company equity documents.

 

The redemption value of the Class A common shares at June 30, 2010 and December 31, 2009 totaled $42.7 million and $133.1 million, respectively, which includes $27.3 million and $24.3 million, respectively, of aggregate intrinsic value of outstanding unexercised vested stock options.  Due to the January 24, 2010 Personal Enrichment Plan amendment, the redemption features were eliminated on 2.8 million of Class A common shares at a fair value of $32.00 per share during the six months ended March 31, 2010.

 

The redemption value of the Class C qualified employee retirement plan shares at June 30, 2010 and December 31, 2009 totaled $8.2 million and $8.4 million, respectively.  There were no Class C common shares redeemed by the Company during the six months ended June 30, 2010.

 

During the three months ended June 30, 2010, the Company loaned $9.6 million to the Personal Enrichment Plan to fund annual common stock purchases from employees who retired or terminated employment with the Company.  The loan was made in anticipation of the Company’s public registration of Quad/Graphics common shares owned by the Personal Enrichment Plan as part of

 

14



Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

the Company’s overall public registration of its Class A common shares.  The loan will be repaid by December 31, 2010 and is interest free.

 

Subsequent changes to the redemption value of the securities are charged to retained earnings.  During the six months ended June 30, 2010 the balance of redeemable equity decreased by $90.6 million.  Additional information regarding the changes in redeemable equity for the six months ended June 30, 2010 is provided in the table below:

 

 

 

Class A Common Stock

 

Class C Common Stock

 

Total Redeemable

 

 

 

Shares

 

Redemption Value

 

Shares

 

Redemption Value

 

Equity

 

Balance at December 31, 2009

 

3.3

 

$

133.1

 

0.3

 

$

8.4

 

$

141.5

 

Cash dividends declared

 

 

(1.7

)

 

(0.1

)

(1.8

)

Elimination of redemption features

 

(2.8

)

(89.6

)

 

 

(89.6

)

Stock-based compensation charges

 

 

2.5

 

 

 

2.5

 

Sale of stock for options exercised

 

 

0.2

 

 

 

0.2

 

Decrease in redemption value of redeemable equity and other

 

 

(1.8

)

 

(0.1

)

(1.9

)

Balance at June 30, 2010

 

0.5

 

$

42.7

 

0.3

 

$

8.2

 

$

50.9

 

 

On July 6, 2010, the Company’s Class A common shares commenced trading on The New York Stock Exchange.  Further, shares related to the Company’s non-qualified stock option plans will be registered with the SEC during the third quarter of 2010.  Based on the registration of the shares related to the non-qualified stock option plans, a readily tradable market will exist for the Company’s Class A common shares related to exercised and vested stock option grants, thereby eliminating the put right under the applicable stock option agreements.  This will result in the related value ($42.7 million as of June 30, 2010) being reclassified from redeemable equity to common stock and other equity on the September 30, 2010 consolidated balance sheet.

 

Redeemable equity, common stock and other equity and noncontrolling interests

 

The following table summarizes the Company’s equity activity for the six months ended June 30, 2010:

 

 

 

Quad/Graphics
Redeemable Equity

 

Quad/Graphics
Common Stock and
Other Equity

 

Noncontrolling
Interests

 

Balance at December 31, 2009

 

$

141.5

 

$

781.6

 

$

0.3

 

Net loss attributable to Quad/Graphics common shareholders

 

 

(44.2

)

 

Net earnings attributable to noncontrolling interests

 

 

 

0.1

 

Foreign currency translation adjustments

 

 

(20.6

)

 

Cash dividends declared

 

(1.8

)

(12.2

)

 

Tax distribution dividends declared

 

 

(7.1

)

 

Elimination of redemption features

 

(89.6

)

89.6

 

 

Stock-based compensation charges

 

2.5

 

 

 

Sale of stock for options exercised

 

0.2

 

 

 

Decrease in redemption value of redeemable equity and other

 

(1.9

)

1.9

 

 

Balance at June 30, 2010

 

$

50.9

 

$

789.0

 

$

0.4

 

 

Note 15. Comprehensive (Loss) Income

 

The following table summarizes the Company’s comprehensive (loss) income for the three and six months ended June 30, 2010 and 2009:

 

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Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net loss

 

$

(35.6

)

$

(7.2

)

$

(44.1

)

$

(11.7

)

Translation adjustments

 

(12.2

)

13.8

 

(20.6

)

1.4

 

Net change in unrealized gain on cash flow hedges

 

 

 

 

2.5

 

Comprehensive (loss) income

 

$

(47.8

)

$

6.6

 

$

(64.7

)

$

(7.8

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income attributable to noncontrolling interests

 

(0.1

)

 

(0.1

)

 

 

 

 

 

 

 

 

 

 

 

Comprehensive (loss) income attributable to Quad/Graphics common shareholders

 

$

(47.9

)

$

6.6

 

$

(64.8

)

$

(7.8

)

 

Note 16. Segment Information

 

The Company operates primarily in the commercial print portion of the printing industry, with related product and service offerings designed to offer customers complete solutions for communicating their messages to target audiences.  The Company’s operating and reportable segments are aligned with how the chief operating decision maker of the Company currently manages the business.  The Company’s reportable and operating segments and their product and service offerings are summarized below:

 

U.S. Print and Related Services

 

The U.S. Print and Related Services segment includes the Company’s U.S. printing operations, managed as one integrated platform.  This segment’s products include catalogs, consumer magazines, special interest publications, direct marketing materials and retail inserts.  The related service offerings include digital photography, digital imaging, binding, mailing and distribution, and data optimization and analytics services.  This segment also includes the design, development, manufacture and service of printing-related auxiliary equipment, as well as the manufacture of ink.

 

International

 

The International segment includes the Company’s non-U.S. printing operations in Europe and South America.  This segment provides printed products and related services consistent with the U.S. Print and Related Services segment, with the exception of printing-related auxiliary equipment.

 

Corporate

 

Corporate consists of unallocated general and administrative activities and associated expenses including, in part, executive, legal, finance, information technology and human resources.

 

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Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

 

 

Net Sales

 

Operating

 

Restructuring,
impairment and
transaction-related

 

 

 

Products

 

Services

 

Income/(Loss)

 

charges

 

Three months ended June 30, 2010

 

 

 

 

 

 

 

 

 

U.S. Print and Related Services

 

$

290.0

 

$

46.0

 

$

11.7

 

$

0.8

 

International

 

55.5

 

2.8

 

(28.9

)

25.6

 

Total operating segments

 

345.5

 

48.8

 

(17.2

)

26.4

 

Corporate

 

 

 

(6.5

)

4.9

 

Total

 

$

345.5

 

$

48.8

 

$

(23.7

)

$

31.3

 

Three months ended June 30, 2009

 

 

 

 

 

 

 

 

 

U.S. Print and Related Services

 

$

291.6

 

$

42.6

 

$

13.8

 

$

2.4

 

International

 

52.0

 

2.6

 

(4.0

)

0.1

 

Total operating segments

 

343.6

 

45.2

 

9.8

 

2.5

 

Corporate

 

 

 

(1.6

)

 

Total

 

$

343.6

 

$

45.2

 

$

8.2

 

$

2.5

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2010

 

 

 

 

 

 

 

 

 

U.S. Print and Related Services

 

$

588.7

 

$

95.6

 

$

29.5

 

$

0.9

 

International

 

108.1

 

5.5

 

(33.7

)

25.6

 

Total operating segments

 

696.8

 

101.1

 

(4.2

)

26.5

 

Corporate

 

 

 

(15.5

)

11.1

 

Total

 

$

696.8

 

$

101.1

 

$

(19.7

)

$

37.6

 

Six months ended June 30, 2009

 

 

 

 

 

 

 

 

 

U.S. Print and Related Services

 

$

598.0

 

$

93.6

 

$

27.8

 

$

8.6

 

International

 

107.0

 

5.7

 

(4.3

)

0.1

 

Total operating segments

 

705.0

 

99.3

 

23.5

 

8.7

 

Corporate

 

 

 

(4.0

)

 

Total

 

$

705.0

 

$

99.3

 

$

19.5

 

$

8.7

 

 

Restructuring, impairment and transaction-related charges by segment for the three and six months ended June 30, 2010 and 2009 are further described in Note 4.

 

Note 17. Subsequent Events

 

On July 2, 2010, the Company and World Color Press completed the acquisition contemplated in the definitive arrangement agreement entered into on January 25, 2010, pursuant to which World Color Press became a wholly-owned subsidiary of the Company.  In connection with the closing of the acquisition, the Company registered its Class A common stock with the SEC under the Securities Exchange Act of 1933, as amended, and on July 6, 2010, Quad/Graphics’ Class A common stock commenced trading on The New York Stock Exchange under the symbol “QUAD”.  At the completion of the acquisition, each outstanding World Color Press common share, including the common shares issued upon conversion of certain World Color Press preferred shares, was converted into the right to receive 0.2154 shares of Class A common stock of Quad/Graphics.  In total, the World Color Press common shareholders received 18,734,045 shares of Quad/Graphics Class A common stock (subject to fractional share cash-outs).  In addition to the share consideration, former holders of World Color Press common shares received aggregate cash consideration of $48.4 million, or approximately $0.56 per share.  Immediately following the completion of the acquisition, the shareholders of Quad/Graphics who were shareholders prior to completion of the acquisition owned approximately 60% of the outstanding capital stock of Quad/Graphics and former common shareholders of World Color Press owned approximately 40% of the outstanding capital stock of Quad/Graphics.  Quad/Graphics also provided $44.9 million of cash consideration to purchase all outstanding World Color Press warrants and to fund redemptions of or payments due on any other equity securities not converted to common shares, including dividends on preferred shares.

 

Based on this consideration, the total purchase price to consummate the acquisition of World Color Press was as follows:

 

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Table of Contents

 

QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

 

 

Purchase Price

 

New Quad/Graphics Class A common shares issued

 

18.734045

 

Average Quad/Graphics Class A common share price on July 6, 2010

 

$

48.50

 

Stock Consideration

 

908.6

 

Cash Consideration

 

93.3

 

Purchase Price

 

$

1,001.9

 

 

Concurrent with the closing of the acquisition, Quad/Graphics received a $250.0 million advance on the revolving credit facility and $700.0 million for the term loan portion of the $1.23 billion debt financing agreement discussed in Note 10.  These amounts, as well as Quad/Graphics and World Color Press cash, were used on the July 2, 2010 closing date of the acquisition to fund:

 

(1)             Replacement of Quad/Graphics’ former revolving credit facilities, which had outstanding borrowings of $106.1 million (including interest owed and payment of the debt issuance costs on the new debt financing agreement of $43.7 million);

(2)             Satisfaction of certain World Color Press debt obligations of $571.4 million, which included funding of $123.9 million to defease the World Color Press’ unsecured notes (of which $34.7 million was returned to the Company on August 2, 2010 upon the unsecured notes being called by the Company);

(3)             Transaction costs of $53.1 million (excluding debt issuance costs);

(4)             Redemption of outstanding World Color Press equity securities (consisting of preferred shares, warrants, deferred share units and restricted share units) and the cash consideration paid to the former World Color Press common shareholders described above, which in total were $88.5 million (in addition to $4.8 million of preferred dividends which had been paid after the January 25, 2010 date of the executed arrangement agreement but prior to July 2, 2010);

(5)             Distribution of $140.0 million to Quad/Graphics’ then existing common shareholders;

(6)             Collateralization of letters of credit of $32.0 million; and

(7)             Other obligations arising from the acquisition of $33.3 million.

 

Quad/Graphics and World Color Press have incurred transaction costs as part of the acquisition, including those amounts listed above as well as amounts paid at other times than the acquisition closing date.  The combined company transaction costs that are directly attributable to the acquisition and that do not have a continuing impact on the combined company are estimated to be $123.7 million (including debt issuance costs).  Other than the $56.2 million of debt issuance costs that are being capitalized within other long-term assets on the consolidated balance sheet, the remaining $67.5 million of transaction costs are to be expensed as incurred in accordance with the acquisition method of accounting and classified as restructuring, impairment and transaction-related charges on the consolidated statement of operations.

 

The following unaudited pro forma combined financial information presents the results of the Company as though Quad/Graphics and World Color Press had combined as of January 1, 2009.  The pro forma information has been prepared with the following considerations:

 

(1)          The unaudited pro forma consolidated financial information has been prepared using the acquisition method of accounting under existing GAAP.  Quad/Graphics is the acquirer for accounting purposes.

(2)          World Color Press historical amounts have been converted from Canadian generally accepted accounting principles to GAAP.

(3)          On July 21, 2009, upon emergence from bankruptcy protection in Canada and the United States, World Color Press was required to adopt “fresh start” financial accounting per the latest GAAP guidance.  Under fresh start accounting, World Color Press undertook a comprehensive re-evaluation of its assets and liabilities and World Color Press became a new entity for financial reporting purposes (that new entity referred to as the “successor”, and the periods prior to fresh start date are referred to as the periods of the “predecessor”).  Fresh start accounting was adopted as of the nearest month-end date of July 31, 2009, as the activity between July 22, 2009 and July 31, 2009 was deemed by World Color Press to be immaterial.  For the purposes of the pro forma combined financial information for 2009 presented below, the three and six months of predecessor activity from January 1, 2009 through June 30, 2009 has been adjusted to reflect what the three and six months of activity would have been on a successor basis.

(4)          The pro forma combined financial information does not reflect any operating synergies that the combined company may achieve as a result of the acquisition, the costs necessary to achieve these operating synergies or additional charges necessary as a result of the integration.

 

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QUAD/GRAPHICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010

(In millions, except per share data and unless otherwise indicated)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Pro forma net sales

 

$

1,075.3

 

$

1,095.8

 

$

2,170.9

 

$

2,268.3

 

Pro forma net earnings (loss) attributable to common shareholders

 

$

(5.3

)

$

9.0

 

$

(23.1

)

$

(48.0

)

Pro forma earnings (loss) per share attributable to common shareholders

 

$

(0.11

)

$

0.19

 

$

(0.49

)

$

(1.02

)

 

The purchase price allocation will be based on the fair values of the World Color Press assets and liabilities as of the consummation of the acquisition.  As of the date of these financial statements, the Company has not completed the detailed valuation studies necessary to arrive at the required estimates of the fair value of the World Color Press assets acquired and the World Color Press liabilities assumed, and thus the asset and liability values are based on preliminary estimates that are subject to adjustment.  The final valuation of the assets, liabilities and resulting goodwill could have a material impact on the pro forma combined statement of operations amounts listed above.

 

As a result of the acquisition and the public registration of Quad/Graphics Class A common stock, the Company changed the tax status of certain entities within the Quad/Graphics legal structure to C corporation status as of the Termination Date under the provisions of the Internal Revenue Code of 1986, as amended.  From that point forward, these entities will be subject to federal and state income taxes.  The impact from the conversion to C corporation status resulted in recognition during the third quarter of 2010 of net short-term deferred tax assets of approximately $25 million, net long-term deferred tax liabilities of approximately $230 million, an increase in accumulated other comprehensive loss due to the impact of foreign currency translation of approximately $10 million, and recognition of income tax expense of approximately $195 million.

 

On August 5, 2010, the Company announced the closure of four additional printing plants and the acceleration of the closure of a previously announced plant, with the five plants to be closed totaling 2.7 million square feet and employing approximately 2,200 employees.   These plants are expected to be closed by the end of 2010.  Costs associated with exiting these plants are estimated to be approximately $60 million and consist primarily of $35 million in asset related charges, including impairments, cost of relocation or disposal of assets and other costs to ready the plants for sale, $14 million in anticipated employee severance costs, $9 million in related costs to exit certain utility contracts and $2 million in other general closure costs.  Cash costs associated with the $60 million in estimated charges are expected to be approximately $25 million, after consideration for the expected cash proceeds on the sale of these facilities.

 

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Table of Contents

 

ITEM 2.       Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

The following discussion of the financial condition and results of operations of Quad/Graphics should be read together with (1) the Quad/Graphics condensed consolidated financial statements for the three and six months ended June 30, 2010 and 2009, including the notes thereto, included elsewhere in this report and (2) the audited consolidated annual financial statements as of and for the year ended December 31, 2009 and notes thereto included in the Company’s Registration Statement on Form S-4/A (Registration No. 333-165259) filed with the SEC on May 26, 2010.

 

Management’s discussion and analysis of financial condition and results of operations is provided as a supplement to the Company’s consolidated financial statements and accompanying footnotes to help provide an understanding of the Company’s financial condition, the changes in the Company’s financial condition and the Company’s results of operations.  This discussion and analysis is organized as follows:

 

·      Cautionary Statement Regarding Forward-Looking Statements.

 

·      Overview.  This section includes a general description of the Company’s business and segments, an overview of key performance metrics the Company’s management measures and utilizes to evaluate business performance, a discussion of the completion of the World Color Press Inc. (sometimes referred to as World Color Press) acquisition, and an overview of trends affecting the Company including management’s actions related to the trends.

 

·                  Results of operations.  This section contains an analysis of the Company’s results of operations by comparing the results for (1) the three months ended June 30, 2010 to the three months ended June 30, 2009 and (2) the six months ended June 30, 2010 to the six months ended June 30, 2009.  This analysis is based on the Company’s pre-acquisition results, without the operating results of World Color Press.  Forward-looking statements providing a general description of recent and projected industry and company developments that are important to understanding the Company’s results of operations are included in this section.  This section also provides a discussion of EBITDA and EBITDA margin, non-GAAP financial measures the Company uses to assess the performance of its business.

 

·                  Liquidity and capital resources.  This section provides an analysis of the Company’s capitalization and cash flows.  This analysis is based on the Company’s pre-acquisition amounts, unless specifically indicated otherwise.  Forward-looking statements important to understanding the Company’s financial condition are also included in this section.

 

·                  Recent and new accounting pronouncements.  This section provides a discussion of recent accounting pronouncements that the Company believes are important to understanding the Company’s current and forward-looking results of operations and financial condition.

 

Cautionary Statement Regarding Forward-Looking Statements

 

To the extent any statements in this Quarterly Report on Form 10-Q contain information that is not historical, these statements are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements relate to, among other things, Quad/Graphics’ objectives, goals, strategies, beliefs, intentions, plans, estimates, prospects, projections and outlook, and can generally be identified by the use of words such as “may”, “will”, “expect”, “intend”, “estimate”, “anticipate”, “plan”, “foresee”, “believe” or “continue” or the negatives of these terms, variations on them and other similar expressions.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements.

 

These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond the control of the Company.  These risks, uncertainties and other factors could cause actual results to differ materially from those expressed or implied by those forward-

 

20



Table of Contents

 

looking statements.  Among risks, uncertainties and other factors that may impact Quad/Graphics are those described under the heading “Risk Factors” in the Company’s Registration Statement on Form S-4/A (Registration No. 333-165259), filed with the SEC on May 26, 2010, as may be amended or supplemented in Part II, Item 1A of the Company’s subsequently filed Quarterly Reports on Form 10-Q (including this report), and the following:

 

·      Unexpected costs or liabilities related to the recently completed acquisition of World Color Press, including the effects of purchase accounting that may be different from Quad/Graphics’ expectations;

·      Quad/Graphics may be unable to achieve the estimated potential synergies expected from the acquisition or it may take longer or cost more than expected to achieve those synergies;

·      Failure to successfully integrate the operations of Quad/Graphics and World Color Press;

·      Changes in industry conditions, such as the competitive environment for companies in the printing industry;

·      Regulatory and litigation matters and risks;

·      Legislative developments or changes in laws;

·      Changes in macroeconomic conditions in the countries where Quad/Graphics operates, including the impact of such conditions on future volume and pricing;

·      The impact of fluctuations in interest rates, commodity prices and foreign exchange rates;

·      The effects of changes in political conditions and developments in the countries where Quad/Graphics operates; and

·      The effect of accounting pronouncements issued periodically by standard-setting bodies.

 

Because forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.  You are cautioned not to place undue reliance on such statements, which speak only as of the date of this Quarterly Report on Form 10-Q, when making decisions with respect to Quad/Graphics.  Except to the extent required by the federal securities laws, Quad/Graphics undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Overview

 

Business Overview

 

Quad/Graphics is a leading global provider of print and related services.  Operating primarily in the commercial print portion of the printing industry, the Company produces and delivers products and services designed to provide customers complete solutions for communicating their messages to target audiences.  The Company’s print products primarily include catalogs, consumer magazines, special interest publications, direct marketing materials and retail inserts.  Print-related services the Company provides include digital photography, digital imaging, binding, mailing and distribution, and data optimization and analytics services.  In addition, substantial investments are made in research and development and other technological innovations, and the Company has developed multiple manufacturing process improvements, including innovative press and finishing control systems and material-handling equipment for use in its own print operations as well as for sale to other printers worldwide.  The Company manufactures ink, which is solely used in its own printing process.

 

The Company’s operating and reporting segments are aligned with how the Company’s chief operating decision maker currently manages the business.  The Company has three segments: U.S. Print and Related Services, International, and Corporate.

 

The U.S. Print and Related Services segment includes the Company’s United States printing operations, managed as one integrated platform.  This segment includes all of the product and related service offerings described above.  The U.S. Print and Related Services segment accounted for approximately 86% of the Company’s consolidated net sales in the three and six months ended June 30, 2010 and 2009.

 

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Table of Contents

 

The International segment includes Quad/Graphics’ printing operations in Europe and South America, which currently include the operations of Quad/Winkowski Sp. z o. o., located in Poland (sometimes referred to as Quad/Winkowski); Anselmo L. Morvillo S.A., located in Argentina (sometimes referred to as Morvillo); and Plural Editora e Gráfica, Ltda., located in Brazil (sometimes referred to as Plural).  This segment produces and delivers all of Quad/Graphics’ product and service offerings in Europe and South America, with the exception of printing-related auxiliary equipment, which is included in the U.S. Print and Related Services segment.  The International segment accounted for approximately 14% of the Company’s consolidated net sales in the three and six months ended June 30, 2010 and 2009.

 

The Corporate segment consists of unallocated general and administrative activities and associated expenses including, in part, executive, legal, finance, information technology and human resources.

 

Key Performance Metrics Overview

 

The Company’s management believes the ability to generate net sales growth and positive cash flow are key indicators of the successful execution of the Company’s business strategy and will increase shareholder value.  The Company uses period over period net sales growth, EBITDA, EBITDA margin and cash flows provided by operating activities as metrics to measure operating performance and financial condition.  EBITDA and EBITDA margin are non-GAAP financial measures (see the reconciliation of net earnings attributable to Quad/Graphics common shareholders to EBITDA in the Results of Operations section below).

 

Net sales growth.  The Company uses period over period net sales growth as a key performance metric. The Company’s management assesses net sales growth based on the ability to generate increased net sales through increased sales to existing customers, sales to new customers, sales of new or expanded solutions to existing and new customers and opportunities to expand revenue through strategic investments, including acquisitions.

 

EBITDA and EBITDA margin.  The Company uses EBITDA and EBITDA margin as metrics to assess operating performance.  The Company’s management assesses EBITDA and EBITDA margin based on the ability to increase revenues while controlling variable expense growth.

 

Cash flows provided by operating activities.  The Company uses cash flows provided by operating activities as a metric to assess liquidity.  The Company’s management assesses cash flows provided by operating activities based on the ability to meet recurring cash obligations while increasing available cash to fund capital expenditures, debt service requirements, strategic investments and potential dividend payments to shareholders.

 

Completion of the World Color Press Acquisition

 

On July 2, 2010, subsequent to the end of the second quarter, the Company and World Color Press completed the transaction contemplated in the definitive arrangement agreement entered into on January 25, 2010, pursuant to which World Color Press became a wholly-owned subsidiary of the Company.  In connection with the closing of the acquisition, the Company registered its Class A common stock with the SEC under the Securities Exchange Act of 1933, as amended, and on July 6, 2010, Quad/Graphics Class A common stock commenced trading on The New York Stock Exchange under the symbol “QUAD”.

 

The combined company is positioned as a leader in the printing industry with a deeper talent pool, greater geographic reach (including the Canadian marketplace and certain Latin American markets where Quad/Graphics previously did not have a significant presence) and broader product and service offerings (including the printing of books and directories, which Quad/Graphics previously did not print, as well as an increased range of retail and direct mail products).  The combined company intends to optimize plant and machine utilization, optimize mailing and logistics utilization, and realize purchasing efficiencies across its expanded manufacturing platform.  Management expects to realize pre-tax cost synergies of $225 million annually within 24 months after completion of the acquisition.  Although management expects that synergies will result from the acquisition, there can be no assurance that these synergies will be achieved.  To realize these expected synergies, the total integration-related charges are estimated to be in the range of $195 million to $240 million, which will be expensed as incurred. 

 

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Table of Contents

 

In addition, transaction costs to complete the acquisition are expected to be approximately $124 million.  Excluding $56 million of debt issuance costs, which will be capitalized and amortized over the term of the new debt financing agreement discussed in the Liquidity and Capital Resources below, the remainder will be expensed as incurred.  World Color Press’ results of operations and account balances have been included in the Company’s results of operations and balance sheet prospectively from the July 2, 2010 transaction date.

 

As a result of the acquisition and the public registration of the Quad/Graphics Class A common stock, the Company changed the tax status of certain entities within the Quad/Graphics legal structure to C corporation status subsequent to the end of the second quarter.  From that point forward, these entities became subject to federal and state income taxes.  The impact from the conversion to C corporation status resulted in recognition during the third quarter of 2010 of net short-term deferred tax assets of approximately $25 million, net long-term deferred tax liabilities of approximately $230 million, an increase in accumulated other comprehensive loss due to the impact of foreign currency translation of approximately $10 million, and recognition of income tax expense of approximately $195 million.

 

Overview of Trends Affecting Quad/Graphics

 

The challenges posed by the global economic recession have continued into the second quarter of 2010, although the recession’s impact on the business appears to be stabilizing, as evidenced by the Company’s $5.5 million, or 1.4%, increase in net sales for the three month period ended June 30, 2010 as compared to the same period in 2009.  The impact of the economic recession on consumer spending has led to reduced advertising and marketing spending, causing some printing businesses to fail and consolidation within the printing industry.  The industry consolidation and decreasing print volumes have created excess capacity in the industry, which has led to increased pricing pressures.  Even with the industry consolidation, the printing industry remains highly fragmented and highly competitive.

 

The Company has implemented productivity and restructuring initiatives to lower operating costs.   The Company has been and remains diligent in implementing productivity improvements through automation and a focus on lean manufacturing principles, which has created the ability to reduce crew sizes while maintaining high service levels to customers.  To improve efficiencies in the Company’s International segment, on June 16, 2010, the Company announced a plant closure in Poland that is intended to strengthen its position as a leading European printer by consolidating its operations into one, large-scale production facility.  Subsequent to the end of the second quarter and the closing of the acquisition of World Color Press, the Company eliminated redundant selling and administrative (including corporate) positions.  Additionally, on August 5, 2010, the Company announced the closure of four additional printing plants and the acceleration of the closure of a previously announced plant in the United States, with the five plants to be closed totaling 2.7 million square feet and employing approximately 2,200 employees.  Costs associated with exiting these five U.S. plants are estimated to be approximately $60 million and consist primarily of $35 million in asset related charges, including impairments, cost of relocation or disposal of assets and other costs to ready the plants for sale, $14 million in anticipated employee severance costs, $9 million in related costs to exit certain utility contracts and $2 million in other general closure costs.  Cash costs associated with the $60 million in estimated charges are expected to be $25 million, after consideration for the expected cash proceeds on the sale of these facilities.  All of these plants are expected to be closed by the end of 2010.  Looking forward, the Company intends to continue to implement appropriate restructuring actions in order to arrive at an optimal manufacturing footprint following the acquisition of World Color Press.  Upon the completion of the integration of World Color Press, management believes the Company will be positioned with an efficient and modern manufacturing platform, leading distribution capabilities and a lower cost structure.

 

 The Company operates in a capital intensive industry.  Even in periods of machinery overcapacity, significant recurring equipment and technology capital expenditures are required in the printing industry to deliver customer expected solutions.  The Company believes that its in-house research and development and a continuous improvement mentality toward printing technology has been and will be important to its success.

 

The Company is also subject to seasonality in its quarterly results as net sales are typically higher in the third and fourth quarters of the calendar year as compared to the first and second quarters.  Seasonality is driven by increased magazine advertising page counts and retail inserts and catalogs due primarily to back-to-school and

 

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Table of Contents

 

holiday related advertising and promotion.  Additionally, the Company’s sales in the last six months of 2010 will include the results of World Color Press, which was acquired on July 2, 2010.  Thus, net sales during the first six months of 2010 are not a reliable predictor for what net sales will be during the last six months of 2010.

 

Results of Operations for the Three Months Ended June 30, 2010 Compared to the Three Months Ended June 30, 2009

 

Summary Results

 

The Company’s operating income (loss), operating margin and loss per share attributable to Quad/Graphics common shareholders—diluted for the three months ended June 30, 2010 changed from the three months ended June 30, 2009 as follows (dollars in millions, except per share data):

 

 

 

Operating Income
(Loss)

 

Operating Margin

 

Earnings (Loss) Per Share
Attributable to
Quad/Graphics Common
Shareholders—Diluted

 

For the Three Months Ended June 30, 2009

 

$

 8.2

 

2.1

%

$

 (0.25

)

2010 Restructuring, Impairment and Transaction-Related Charges(1)

 

(31.3

)

(7.9

)%

(1.11

)

2009 Restructuring and Impairment Charges(2)

 

2.5

 

0.6

%

0.09

 

Reduction in Income Tax Expense(3)

 

N/A

 

N/A

 

0.06

 

Reduction in Operating Income(4)

 

(3.1

)

(0.8

)%

(0.06

)

For the Three Months Ended June 30, 2010

 

$

 (23.7

)

(6.0

)%

$

 (1.27

)

 


(1)   2010 Restructuring, impairment and transaction-related charges of $31.3 million incurred during the three months ended June 30, 2010 included:

a.     $1.2 million of legally required severance for the Poland plant closure (International segment);

b.     $24.4 million of impairment charges on assets for the Poland plant closure (International segment);

c.     $2.7 million of transaction costs in connection with the acquisition of World Color Press (Corporate segment);

d.     $2.2 million of integration costs incurred in connection with the acquisition of World Color Press (Corporate segment);

e.     $0.8 million of lease termination costs (U.S. Print and Related Services segment).

 

The Company expects to incur substantial additional costs in future reporting periods, including the additional transaction-related expenses for completing the World Color Press acquisition, as well as restructuring and integration costs.

 

(2)   2009 Restructuring and impairment charges of $2.5 million incurred during the three months ended June 30, 2009 included:

a.     $2.4 million of employee termination costs for 166 headcount reductions in the U.S. Print and Related Services segment.

b.     $0.1 million of employee termination costs for 72 headcount reductions in the International segment.

 

(3)   Income tax expense decreased $1.7 million from income tax expense of $0.2 million during the three months ended June 30, 2009 to a $1.5 million income tax benefit during the three months ended June 30, 2010.  This change is due to the decrease in pre-tax operating income.

 

(4)   Operating income decreased $3.1 million primarily as a result of the Company intentionally maintaining a portion of its skilled work force in the United States at higher levels than required in order to prepare the manufacturing infrastructure to support the anticipated integration of the World Color Press acquisition. 

 

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Additionally, the Company increased its administrative infrastructure for the transition to becoming a public company.  The following discussion provides additional details.

 

Consolidated

 

The following table sets forth certain information from the Company’s consolidated statements of operations on an absolute dollar basis and as a relative percentage of total net sales for each noted period, together with the relative percentage change in such information between the periods set forth below:

 

 

 

Three Months Ended June 30,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

 

(dollars in millions)

 

 

 

 

 

Amount

 

% of
Sales

 

Amount

 

% of
Sales

 

$
Change

 

%
Change

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

$

345.5

 

87.6

%

$

343.6

 

88.4

%

$

1.9

 

0.6

%

Services

 

48.8

 

12.4

%

45.2

 

11.6

%

3.6

 

8.0

%

Total Net Sales

 

394.3

 

100.0

%

388.8

 

100.0

%

5.5

 

1.4

%

Cost of Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

Products

 

255.4

 

64.8

%

250.3

 

64.4

%

5.1

 

2.0

%

Services

 

33.8

 

8.6

%

31.4

 

8.1

%

2.4

 

7.6

%

Total Cost of Sales

 

289.2

 

73.4

%

281.7

 

72.5

%

7.5

 

2.7

%

Selling, General & Administrative Expenses

 

49.3

 

12.5

%

47.4

 

12.2

%

1.9

 

4.0

%

Restructuring, Impairment and Transaction-Related Charges

 

31.3

 

7.9

%

2.5

 

0.6

%

28.8

 

1,152.0

%

Depreciation and Amortization

 

48.2

 

12.2

%

49.0

 

12.6

%

(0.8

)

(1.6

)%

Total Operating Expenses

 

418.0

 

106.0

%

380.6

 

97.9

%

37.4

 

9.8

%

Operating (Loss) Income

 

$

(23.7

)

(6.0

)%

$

8.2

 

2.1

%

$

(31.9

)

(389.0

)%

 

Net Sales

 

Product sales increased for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 primarily as a result of an increase in by-product sales due to increased prices received on recycled paper and increased sales of paper to the Company’s customers, partially offset by continued pricing pressures related to the global economic recession and industry overcapacity.  Printing volumes were essentially flat between the periods.

 

Product sales are most reflective of Quad/Graphics’ business performance because a significant amount of total operating profit is generated from product sales.  In addition, service sales generally correspond with product sales, such that when product sales increase during a period, service sales generally increase as well, and that relationship between product sales and service sales held true during the three months ended June 30, 2010.  The increase in service sales was primarily due to an increase in freight services.

 

Cost of Sales

 

Cost of product sales increased for the three months ended June 30, 2010 compared with the three months ended June 30, 2009 primarily as a result of increased labor costs and an increase in paper sales.  Quad/Graphics intentionally maintained a portion of its skilled labor work force in the United States at higher levels than required in order to prepare the manufacturing infrastructure to support the anticipated integration of the World Color Press acquisition.  Paper is generally billed to customers as pass-through rates, and thus when paper sales increase during a period, the cost of product sales, as well as the cost of product sales as a percentage of net sales, will increase.

 

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Table of Contents

 

Cost of service sales increased for the three months ended June 30, 2010 compared with the three months ended June 30, 2009 primarily due to the increase in fuel costs, which, similar to paper, primarily represents a pass-through to customers.  Therefore, when fuel constitutes a higher percentage of the revenue, cost of service sales as a percentage of net sales increase and the Company’s margins generally decrease.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased for the three months ended June 30, 2010 compared with the three months ended June 30, 2009 primarily as a result of maintaining higher than required levels of administrative staff in the United States in anticipation of the World Color Press acquisition and an increase in administrative personnel to build the infrastructure for the transition from a private to a publicly-traded company (accounting, legal, treasury and other administrative labor), as well as strategic investments in additional sales staff to drive revenue.

 

Restructuring, Impairment and Transaction-Related Charges

 

Restructuring, impairment and transaction-related charges of $31.3 million incurred in the three months ended June 30, 2010 include: (1) $1.2 million of legally required severance for a plant closure in Poland, (2) $24.4 million of impairment charges related to the Poland plant’s assets, (3) $2.7 million of transaction costs incurred in connection with the acquisition of World Color Press, (4) $2.2 million of integration costs incurred in connection with the acquisition of World Color Press and (5) $0.8 million of lease termination costs.  During the three months ended June 30, 2009, there were a total of $2.5 million of restructuring, impairment and transaction-related charges, including $2.4 million of restructuring charges related to 166 domestic headcount reductions and $0.1 million of restructuring charges related to 72 international headcount reductions.

 

Depreciation and Amortization

 

Depreciation and amortization decreased slightly for the three months ended June 30, 2010 compared with the three months ended June 30, 2009 due to a decline in capital expenditures.  Considering the global economic challenges, the Company’s management decided to reduce the level of new capital purchases in 2009 and 2010, which has lowered the amount of overall depreciation.  The decrease in depreciation and amortization was partially offset by a slight increase in amortization expenses.  Amortization expenses, which are relatively low due to Quad/Graphics’ historical growth being achieved almost entirely by organic sales growth rather than through acquisition growth, include the amortization of trademarks, patents, licenses, agreements, capitalized software and acquired technology.  Depreciation of fixed assets and amortization of intangible assets is included in the line item depreciation and amortization in the consolidated statements of operations.

 

EBITDA and EBITDA Margin

 

EBITDA and EBITDA margin decreased for the three months ended June 30, 2010 compared with the three months ended June 30, 2009 primarily due to incremental restructuring, impairment and transaction-related charges recorded during the three months ended June 30, 2010 related to the Poland plant closure and the World Color Press acquisition.  While both the Poland plant closure and the costs incurred with respect to the World Color Press acquisition had detrimental impacts in the current quarter on EBITDA and EBITDA margin, these actions were taken with the intent of improving future EBITDA and EBITDA margins.

 

EBITDA and EBITDA margin for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was as follows:

 

 

 

Three Months Ended June 30,

 

 

 

 

 

2010

 

2009

 

 

 

 

 

Amount

 

% of Net Sales

 

Amount

 

% of Net Sales

 

% Change

 

 

 

(dollars in millions)