Quad/Graphics, Inc.: Form 10-Q for the period ended Mar 31, 2019

The following discussion of the financial condition and results of operations of Quad should be read together with (1) the Quad condensed consolidated financial statements for the three months ended March 31, 2019 and 2018, including the notes thereto, included in Item 1, “Condensed Consolidated Financial Statements (Unaudited),” of this Quarterly Report on Form 10-Q; and (2) the audited consolidated annual financial statements as of and for the year ended December 31, 2018, and notes thereto included in the Company’s Annual Report on Form 10-K, filed with the SEC on February 20, 2019.

Management’s discussion and analysis of financial condition and results of operations is provided as a supplement to the Company’s condensed consolidated financial statements and accompanying notes 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, 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 the three months ended March 31, 2019, to the three months ended March 31, 2018. The comparability of the Company’s results of operations between periods was impacted by the 2019 acquisition of Periscope, the 2018 acquisition of Ivie and the 2018 additional investment in and consolidation of Rise. The results of operations of these acquisitions and investments are included in the Company’s condensed consolidated results prospectively from their respective dates of acquisition or consolidation. 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, financial measures that the Company uses to assess the performance of its business that are not prepared in accordance with GAAP.
• Liquidity and Capital Resources. This section provides an analysis of the Company’s capitalization, cash flows, a statement about off-balance sheet arrangements and a discussion of outstanding debt and commitments. Forward-looking statements important to understanding the Company’s financial condition are included in this section. This section also provides a discussion of Free Cash Flow and Debt Leverage Ratio, non-GAAP financial measures that the Company uses to assess liquidity and capital allocation and deployment.
• New Accounting Pronouncements.

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, the objectives, goals, strategies, beliefs, intentions, plans, estimates, prospects, projections and outlook of the Company, 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-looking statements. Among risks, uncertainties and other factors that may impact Quad are those described in Part I, Item 1A, “Risk Factors,” of the Company’s 2018 Annual Report on Form 10-K, filed with the SEC on February 20, 2019, as such may be amended or supplemented in Part II, “Other Information,” Item 1A, “Risk Factors,” of the Company’s subsequently filed Quarterly Reports on Form 10-Q (including this report), and the following:

• The impact of decreasing demand for printed materials and significant overcapacity in a highly competitive environment creates downward pricing pressures and potential under-utilization of assets;
• The impact of digital media and similar technological changes, including digital substitution by consumers;
• The impact of fluctuations in costs (including labor and labor-related costs, energy costs, freight rates and raw materials) and the impact of fluctuations in the availability of raw materials;
• The failure to successfully identify, manage, complete and integrate acquisitions and investments, including the proposed acquisition of LSC;
• The inability of the Company to reduce costs and improve operating efficiency rapidly enough to meet market conditions;
• The impact of increased business complexity as a result of the Company’s transformation to a marketing solutions provider;
• The impact of regulatory matters and legislative developments or changes in laws, including changes in cyber-security, privacy and environmental laws;
• The impact of changing future economic conditions;
• The failure of clients to perform under contracts or to renew contracts with clients on favorable terms or at all;
• The failure to attract and retain qualified talent across the enterprise;
• Significant capital expenditures may be needed to maintain the Company’s platforms and processes and to remain technologically and economically competitive;
• The impact of changes in postal rates, service levels or regulations;
• The fragility and decline in overall distribution channels, including newspaper distribution channels;
• The impact of the various restrictive covenants in the Company’s debt facilities on the Company’s ability to operate its business;
• The impact of risks associated with the operations outside of the United States, including costs incurred or reputational damage suffered due to improper conduct of its employees, contractors or agents;
• The impact on the holders of Quad’s class A common stock of a limited active market for such shares and the inability to independently elect directors or control decisions due to the voting power of the class B common stock;
• The impact of an other than temporary decline in operating results and enterprise value that could lead to non-cash impairment charges due to the impairment of property, plant and equipment and other intangible

assets; and

• The impacts that the proposed acquisition of LSC may have on the Company, both prior to and following consummation of that acquisition.

Quad cautions that the foregoing list of risks, uncertainties and other factors is not exhaustive, and you should carefully consider the other factors detailed from time to time in Quad’s filings with the SEC and other uncertainties and potential events when reviewing the Company’s forward-looking statements.

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. Except to the extent required by the federal securities laws, Quad 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

As a worldwide marketing solutions partner dedicated to creating a better way, Quad uses its data-driven, integrated marketing solutions platform to help clients reduce complexity, increase efficiency and enhance marketing spend effectiveness. Quad provides its clients with unmatched scale for client on-site services and expanded subject expertise in marketing strategy, creative solutions, media deployment and marketing management services. With a client-centric approach, that drives its expanded offering, combined with leading-edge technology and single-source simplicity, the Company believes it has the resources and knowledge to help a wide variety of clients in multiple vertical industries, including retail, publishing and healthcare.

Quad believes employee pride, combined with a relentless quest to create a better way, builds the opportunity to invent the future as a preferred marketing solutions partner, helping its clients win every day. To accomplish this vision, Quad remains focused on its consistent strategic priorities as follows:

Walk in the Shoes of Clients

The Company encourages all employees, regardless of job title, to walk in the shoes of clients by putting a priority on listening to clients’ needs and challenges, doing what they can to make it easy to work with Quad, and making the client experience enjoyable at every touchpoint. In Quad 3.0, the Company is focused on evolving client print-production conversations to conversations encompassing consultative, enterprise-wide solutions that will create more value for clients. To accomplish this, a key component of Quad’s client-facing strategy is to strengthen relationships at higher levels within a client’s organization so the Company can better understand, anticipate and satisfy the organization’s needs. In Quad 3.0, Quad seeks to become an invaluable strategic marketing partner for its clients, helping them successfully navigate today’s constantly evolving media landscape through innovative data-driven solutions, produced and deployed across multiple media channels. The Company also believes its proactive thought leadership in the key issues facing its clients, including data-driven marketing and postal reform, will foster loyalty to the Quad brand.

Grow the Business Profitably

This strategy centers on Quad’s ability to grow its business at a time when significant media disruption and print industry headwinds continue. Key components of this strategy are as follows:

• Quad 3.0, in which the Company serves as a comprehensive marketing solution partner to its clients. The Company believes its integrated end-to-end marketing solutions platform will create more value than the traditional agency approach that operates in silos and is focused on profit by media channel. Quad’s integrated marketing solutions platform removes the complexity Quad’s clients’ face when working with multiple agency partners, providing a streamlined and simplified approach to help them achieve their marketing goals. In doing so, the Company believes it will increase client efficiencies through workflow re-engineering, content production and process optimization; and improve their client’s overall marketing spend effectiveness through customer insights and analytics, creative services and enhanced personalization leading to more real-time and actionable measurement.
• Organic growth, in which the Company leverages knowledge from existing client relationships in key growth vertical industries to develop complementary products and services that help brand owners market more efficiently and effectively across media channels. Quad is also focused on ensuring it has the right talent in the right positions to facilitate strategic marketing conversations with its clients that lead to a better understanding of their needs, developing tailored solutions and growing market share.
• Disciplined acquisitions, that take many different forms. For example, the Company intends to continue to pursue value-driven industry consolidating acquisitions as well as acquisitions and investments that help accelerate the Company’s transformation in Quad 3.0, such as the proposed acquisition of LSC.

Strengthen the Core

Quad uses a disciplined return on capital framework and historically has made significant investments in its print manufacturing platform and data management capabilities that have resulted in what it believes is the most integrated, automated, efficient, innovative and modern manufacturing platform and distribution network in the printing industry. The Company’s continued focus to strengthen its core manufacturing platform through investments that streamline, automate and improve efficiencies and throughput, while reducing labor costs, promotes sustainable cash flow and continued value creation. Further, Quad’s disciplined culture of holistic Continuous Improvement and commitment to Lean Manufacturing methodologies is a high priority throughout the Company and supports its goal of strengthening the production and distribution functions for core product lines so that Quad can remain the printing industry’s high-quality, low-cost producer.

Empower Employees

Quad’s strategy to empower employees throughout their career journey builds on key aspects of the Company’s distinct corporate culture, which the Company uses to fuel its ongoing Quad 3.0 transformation. These aspects include strong and lasting Company values and an organization-wide entrepreneurial spirit and opportunity-seeking mentality. Employees are encouraged to take pride and ownership in their work, take advantage of continuous learning programs to advance in their careers and improve leadership skills, share knowledge by mentoring others and innovate solutions to drive performance. With the encouragement to do things differently, to be something greater and to create a better way, the Company believes its employees are more fully engaged in producing better results for clients and advancing the Company’s strategic goals, while supporting community activities, initiatives and organizations that impact the quality of life near Quad’s facilities. As Quad continues to expand its integrated marketing platform in Quad 3.0, the Company believes this creates possibilities for each employee that are advantageously distinct from other employers.

Enhance Financial Strength and Create Shareholder Value

Quad follows a disciplined approach to maintaining and enhancing financial strength to create shareholder value, which is essential given ongoing media disruption and printing industry challenges. This strategy is centered on the Company’s ability to maximize net earnings, Free Cash Flow and operating margins; maintain consistent financial policies to ensure a strong balance sheet, liquidity level and access to capital; and retain the financial flexibility needed to strategically allocate and deploy capital as circumstances change. The priorities for capital allocation and deployment are adjusted based on prevailing circumstances and what the Company thinks is best for shareholder value creation at any particular point in time. Those priorities currently include the following: (1) deleveraging the Company’s balance sheet through debt and pension liability reductions; (2) making compelling investments that drive profitable organic growth and productivity in the Company’s print manufacturing and distribution operations, as well as executing on acquisitions through a disciplined approach that includes continued expansion into higher-growth marketing services that help accelerate the Company’s transformation in Quad 3.0, and pursuing value-driven industry consolidation; and (3) returning capital to shareholders through dividends and share repurchases.

To provide ongoing improvement in manufacturing productivity, the Company applies holistic Continuous Improvement and Lean Manufacturing methodologies to simplify and streamline processes and to ultimately maximize operating margins. These same methodologies are applied to its selling, general and administrative functions to create a truly Lean Enterprise. The Company has been working diligently to lower its cost structure by consolidating its manufacturing platform into its most efficient facilities, as well as realizing purchasing, mailing and logistics efficiencies by centralizing and consolidating print manufacturing volumes and eliminating redundancies in its administrative and corporate operations. Quad believes that its focused efforts to be the high-quality, low-cost producer generates increased Free Cash Flow and allows the Company to maintain a strong balance sheet through debt and pension liability reductions. The Company’s disciplined financial approach also allows it to maintain sufficient liquidity and to reduce refinancing risk, with the nearest significant debt maturity not occurring until January 2021.

Segments

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 operating and reportable segments, including their product and service offerings, and a “Corporate” category are summarized below.

• The United States Print and Related Services segment is predominantly comprised of the Company’s United States printing operations and is managed as one integrated platform. This includes retail inserts, publications, catalogs, special interest publications, journals, direct mail, books, directories, in-store marketing and promotion, packaging, newspapers, custom print products, other commercial and specialty printed products and global paper procurement, together with marketing and other complementary services, including consumer insights, audience targeting, personalization, media planning and placement, process optimization, campaign planning and creation, pre-media production, videography, photography, digital execution, print execution and logistics. This segment also includes the manufacture of ink. The United States Print and Related Services segment accounted for approximately 89% of the Company’s consolidated net sales during the three months ended March 31, 2019.
• The International segment consists of the Company’s printing operations in Europe and Latin America, including operations in England, France, Germany, Poland, Argentina, Colombia, Mexico and Peru, as well as investments in printing operations in Brazil and India. This segment provides printed products and marketing and other complementary services consistent with the United States Print and Related Services segment. The International segment accounted for approximately 11% of the Company’s consolidated net sales during the three months ended March 31, 2019.
• Corporate consists of unallocated general and administrative activities and associated expenses including, in part, executive, legal and finance, as well as certain expenses and income from frozen employee retirement plans, such as pension benefit plans.

Key Performance Metrics Overview

The Company’s management believes the ability to generate net sales growth, profit increases and positive cash flow, while maintaining the appropriate level of debt, 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, net cash provided by operating activities, Free Cash Flow and Debt Leverage Ratio as metrics to measure operating performance, financial condition and liquidity. EBITDA, EBITDA margin, Free Cash Flow and Debt Leverage Ratio are non-GAAP financial measures (see the definitions of EBITDA, EBITDA margin and the reconciliation of net earnings (loss) attributable to Quad common shareholders to EBITDA in the “Results of Operations” section below, and see the definitions of Free Cash Flow and Debt Leverage Ratio, the reconciliation of net cash provided by operating activities to Free Cash Flow, and the calculation of Debt Leverage Ratio in the “Liquidity and Capital Resources” 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 clients, sales to new clients, sales of new or expanded solutions to existing and new clients and opportunities to expand sales 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.

Net cash provided by operating activities. The Company uses net cash provided by operating activities as a metric to assess liquidity. The Company’s management assesses net cash provided by operating activities based on the ability to meet recurring cash obligations while increasing available cash to fund cash restructuring requirements related to cost reduction activities, as well as to fund capital expenditures, debt service requirements, World Color Press single employer pension plan contributions, World Color Press MEPPs withdrawal liabilities, acquisitions and other investments in future growth, shareholder dividends and share repurchases. Net cash provided by operating activities can be significantly impacted by the timing of non-recurring or infrequent receipts or expenditures.

Free Cash Flow. The Company uses Free Cash Flow as a metric to assess liquidity and capital deployment. The Company’s management assesses Free Cash Flow as a measure to quantify cash available for strengthening the balance sheet (debt and pension liability reduction), for strategic capital allocation and deployment through investments in the business (acquisitions and strategic investments) and for returning capital to the shareholders (dividends and share repurchases). The Company’s priorities for capital allocation and deployment will change as circumstances dictate for the business, and Free Cash Flow can be significantly impacted by the Company’s restructuring activities and other unusual items.

Debt Leverage Ratio. The Company uses the Debt Leverage Ratio as a metric to assess liquidity and the flexibility of its balance sheet. Consistent with other liquidity metrics, the Company monitors the Debt Leverage Ratio as a measure to determine the appropriate level of debt the Company believes is optimal to operate its business, and accordingly, to quantify debt capacity available for strategic capital allocation and deployment through investments in the business (capital expenditures, acquisitions and strategic investments), for strengthening the balance sheet (pension liability reduction), and for returning capital to the shareholders (dividends and share repurchases). The priorities for capital allocation and deployment will change as circumstances dictate for the business, and the Debt Leverage Ratio can be significantly impacted by the amount and timing of large expenditures requiring debt financing, as well as changes in profitability.

The Company remains disciplined with its debt leverage. The Company’s consolidated debt and finance leases increased $201 million during the three months ended March 31, 2019, primarily to fund the acquisition of Periscope. Since the Company completed the World Color Press acquisition in July 2010, the Company has reduced debt and finance leases by $598 million and has reduced the obligations for pension, postretirement and MEPPs by $432 million, for a total obligation reduction since July of 2010 of over $1.0 billion.

The Company believes that a disciplined approach for capital management and a strong balance sheet are critical to be able to invest in profitable growth opportunities and technological advances, thereby providing the highest return for shareholders. Management balances the use of cash between deleveraging the Company’s balance sheet (through reduction in debt and pension obligations), compelling investment opportunities (through capital expenditures, acquisitions and strategic investments) and returns to shareholders (through share repurchases and a quarterly dividend of $0.30 per share).

The Company is subject to seasonality in its quarterly results as net sales and operating income are higher in the third and fourth quarters of the calendar year as compared to the first and second quarters. The fourth quarter is typically the highest seasonal quarter for cash flows from operating activities and Free Cash Flow due to the reduction of working capital requirements that reach peak levels during the third quarter. Seasonality is driven by increased magazine advertising page counts, retail inserts, catalogs and books primarily due to back-to-school and holiday-related advertising and promotions. The Company expects this seasonality impact to continue in future years.

Overview of Trends Affecting Quad

As consumer media consumption habits change, marketing services providers face increased demand to offer end-to-end marketing services, from strategy and creative through execution, across all media channels. As new marketing and advertising channels emerge, marketing services providers must expand their services beyond traditional channels such as for television, newspapers, print publications and radio, to digital channels such as mobile, internet search, internet display and video, to create effective multichannel campaigns for their clients. This trend greatly influences Quad’s ongoing efforts to redefine the future of integrated marketing and create greater value for its clients who are looking for less complexity, greater transparency and accountability from their business partners.

In Quad 3.0, the Company leverages its data-driven print expertise as part of an integrated marketing solutions platform that helps its clients not only plan and produce marketing programs, but also deploy, manage and measure them across all media channels. Competition in the printing industry remains highly fragmented and intense, and the Company believes that there are indicators of heightened competitive pressures. The industry has excess manufacturing capacity created by continued declines in industry volumes which, in turn, has created accelerated downward pricing pressures. In addition, digital delivery of documents and data, including the online distribution and hosting of media content and mobile technologies, offer alternatives to traditional delivery of printed documents. Increasing consumer acceptance of digital delivery of content has resulted in marketers and publishers allocating their marketing and advertising spend across the expanding selection of digital delivery options, which further reduces printing demand and contributes to industry overcapacity. The Company also faces competition from print management firms, which look to streamline processes and reduce the overall print spend of the Company’s clients, as well as from strategic marketing firms focused on helping businesses integrate multiple channels into their marketing campaigns.

The Company continues to make progress on integrating and streamlining all aspects of its business, thereby lowering its cost structure by consolidating its manufacturing platform into its most efficient facilities, as well as realizing purchasing, mailing and logistics efficiencies by centralizing and consolidating print manufacturing volumes and eliminating redundancies in its administrative and corporate operations. The Company has continued to evolve its manufacturing platform, equipping facilities to be product line agnostic, which enables the Company to maximize equipment utilization. Quad believes that the large plant size of certain of its key printing facilities allows the Company to drive savings in certain product lines (such as publications and catalogs) due to economies of scale and from investments in automation and technology. The Company continues to focus on proactively aligning its cost structure to the realities of the top-line pressures it faces in the printing industry through Lean Manufacturing and sustainable continuous improvement programs. Restructuring actions initiated by the Company beginning in 2010 have resulted in the announcement of 43 plant closures through March 31, 2019.

The Company believes it will continue to drive productivity improvements and sustainable cost reduction initiatives into the future through an engaged workforce and ongoing adoption of the latest manufacturing automation and technology. Through this strategy, the Company believes it can maintain the strongest, most efficient print manufacturing platform to remain a high-quality, low-cost producer.

Integrated distribution with the postal service is an important component of the Company’s business. Any material change in the current service levels provided by the postal service could impact the demand that clients have for print services. The United States Postal Service (“USPS”) continues to experience financial problems. Without increased revenues or action by Congress to reform the USPS’ cost structure, these losses will continue into the future. Because of these financial difficulties, the USPS has come under increased pressure to adjust its postal rates and service levels. Additional price increases may result in customers reducing mail volumes and exploring the use of alternative methods for delivering a larger portion of their products, such as continued diversion to the internet and other alternative media channels to ensure that they stay within their expected postage budgets.

Current federal law limits postal rate increases (outside of an “exigent circumstance”) to the increase in the Consumer Price Index (“CPI”). This cap works to ensure funding stability and predictability for mailers. However, that same federal statute requires the Postal Regulatory Commission (“PRC”) to conduct a review of the overall rate-making structure for the USPS. The PRC proposed a new rate-making structure that would provide the USPS with additional pricing flexibility over the current CPI cap, and which may result in a substantially altered rate structure for mailers. Any newly revised rates that would be effective because of new rules issued by the PRC may include a higher rate cap, or potentially the elimination of a rate cap altogether, which will result in no restrictions on the USPS’ ability to increase rates from year to year. This may lead to price spikes for mailers and may also reduce the incentive for the USPS to continue to take out costs and instead continue to rely on postage to cover the costs of an outdated postal service that does not reflect the industry’s ability or willingness to pay. The result may be reduced demand for printed products as customers may move more aggressively into other delivery methods, such as the many digital and mobile options now available to consumers.

On April 12, 2018, an executive order was issued for a presidential task force to review the USPS with a provided time frame of 120 days. The recommendations stemming from the presidential task force were published on December 4, 2018, which were wide in scope and will require additional input from a variety of stakeholders, including the United States Congress. The Company expects that with the publication of the report, both postal reform legislation and the PRC’s proposed rate structure changes will be further investigated within the next year.

In 2019, the Company has continued to fuel its Quad 3.0 transformation through acquisitions focused on building out its integrated marketing solutions platform:

• The Company acquired Minneapolis-based creative agency, Periscope, on January 3, 2019, for a preliminary purchase price of $121 million, excluding acquired cash and non-cash equity awards granted. Periscope’s comprehensive offering includes media buying and analytics, creative and account management, as well as packaging design and premedia services that complement Quad’s print-production capabilities. With Periscope, the Company now has a highly efficient global platform for creating marketing campaigns and programs, from strategy and creative through execution, across all media channels. This integrated, end-to-end marketing platform creates more value for clients than the traditional agency approach that operates in silos by reducing complexity and improving process efficiencies and marketing spend effectiveness.
• On October 30, 2018, the Company entered into a definitive agreement to acquire Chicago-based LSC in an all-stock transaction valued at approximately $1.3 billion, including the refinancing of LSC’s debt and assumption of other obligations. The acquisition, which is subject to customary closing conditions, including regulatory approval, is expected to close in mid-2019. The acquisition is expected to create more value for all stakeholders by leveraging a strong print foundation as part of a much larger, more robust integration marketing solutions offering, while broadening Quad’s client base and revenue-generating potential. The transaction presents a compelling opportunity for achieving significant net synergies through the elimination of duplicative functions, capacity rationalization, greater operational efficiencies and greater efficiencies in supply chain management. The Company believes the significant level of synergies will result in a more profitable combined company, and that the all-stock transaction structure is expected to allow Quad to maintain a strong balance sheet, which is expected to create future value for all shareholders.

Results of Operations for the Three Months Ended March 31, 2019, Compared to the Three Months Ended March 31, 2018

Summary Results

The Company’s operating income, operating margin, net loss attributable to Quad common shareholders (computed using a 25% normalized tax rate for all items subject to tax) and diluted loss per share attributable to Quad common shareholders for the three months ended March 31, 2019, changed from the three months ended March 31, 2018, as follows (dollars in millions, except margin and per share data):

(1) Restructuring, impairment and transaction-related charges of $7.6 million, decreased $17.3 million ($13.0 million, net of tax) during the three months ended March 31, 2019, and included the following:

a. A $6.3 million decrease in employee termination charges from $10.6 million during the three months ended March 31, 2018, to $4.3 million during the three months ended March 31, 2019;

b. A $6.2 million decrease in impairment charges from $7.9 million during the three months ended March 31, 2018, to $1.7 million during the three months ended March 31, 2019;

c. A $0.8 million increase in transaction-related charges from $0.7 million during the three months ended March 31, 2018, to$1.5 million during the three months ended March 31, 2019;

d. A $0.7 million increase in integration costs from $0.1 million during the three months ended March 31, 2018, to $0.8 million during the three months ended March 31, 2019; and

e. A $6.3 million decrease in various other restructuring charges from $5.6 million of other restructuring charges during the three months ended March 31, 2018, to $0.7 million of other restructuring income during the three months ended March 31, 2019.

The Company expects to incur additional restructuring and integration costs in future reporting periods in connection with eliminating excess manufacturing capacity and properly aligning its cost structure in conjunction with the Company’s acquisitions and strategic investments, and other cost reduction programs.

(2) Interest expense increased $4.5 million ($3.4 million, net of tax) during the three months ended March 31, 2019, to $21.8 million. This change was due to a higher average debt levels and higher weighted average interest rate on borrowings in the three months ended March 31, 2019, as compared to the three months ended March 31, 2018.

(3) Net pension income decreased $1.6 million ($1.2 million, net of tax) during the three months ended March 31, 2019, to $1.5 million. This was due to a $1.2 million decrease from the change in the expected long-term return on pension plan assets assumption to 6.25% from 6.50%, and a $0.4 million increase from interest cost on pension plan liabilities.

(4) A $15.9 million loss on debt extinguishment ($11.9 million, net of tax) was recognized during the three months ended March 31, 2019, from the refinancing of the Senior Secured Credit Facility, completed on January 31, 2019.

(5) The $0.8 million increase in income tax benefit as calculated in the following table is primarily due to a $1.4 million increased tax benefit from equity award activity, partially offset by a $1.0 million decreased tax benefit from a decrease in the Company’s liability for unrecognized tax benefits.

(6) The decrease from investments in unconsolidated entity and noncontrolling interests, net of tax, of $0.1 million during the three months ended March 31, 2019, was primarily related to a $0.4 million decrease in earnings at the Company’s investment in Plural, partially offset by a favorable impact from the adjustment of the $0.3 million net loss attributed to noncontrolling interests in the Company’s condensed consolidated statements of operations related to the Company’s 57% ownership of Rise.

(7) Operating income, excluding restructuring, impairment and transaction-related charges, decreased $21.5 million ($16.2 million, net of tax impact) during the three months ended March 31, 2019, primarily due to the following: (1) lower print volume and pricing due to ongoing industry pressures; (2) a $16.4 million net benefit in 2018 in gains from property insurance claims; and (3) a $5.0 million benefit in 2018 from changes in employee vacation policies. These decreases were partially offset by the following: (1) a $22.3 million non-cash expense related to a special employee retirement contribution in 2018 resulting from the benefit of tax reform that did not repeat in 2019; (2) savings from cost reduction initiatives, including employee-related costs; and (3) earnings from the Ivie and Periscope acquisitions and investment in Rise.

Operating Results

The following table sets forth certain information from the Company’s condensed 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:

(dollars in millions)

53

Net Sales

Product sales increased $4.0 million, or 0.5%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $22.8 million increase from pass-through paper sales, partially offset by a $10.9 million decrease in sales in the Company’s print product lines due to ongoing industry volume and pricing pressures and $7.9 million in unfavorable foreign exchange impacts.

Service sales, which primarily consist of imaging, logistics, distribution and medical services, increased $33.2 million, or 20.0%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $42.8 million increase in net sales from the Ivie and Periscope acquisitions and the investment in Rise and a $1.4 million increase in logistics sales, partially offset by a $11.0 million decrease in print management and imaging services.

Cost of Sales

Cost of product sales increased $29.8 million, or 4.5%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to an increase in pass-through paper costs and an increase in employee-related costs, primarily due to an increase in production wages. These increases were partially offset by the following: (1) lower print volume and cost reduction initiatives; (2) a $14.0 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019; and (3) a $5.0 million net benefit in 2018 from changes in employee vacation policies.

Cost of product sales as a percentage of total net sales increased to 69.2% for the three months ended March 31, 2019, from 68.8% for the three months ended March 31, 2018, primarily due to the reasons provided above.

Cost of service sales increased $14.9 million, or 11.7%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to the Ivie and Periscope acquisitions and the investment in Rise, partially offset by a $2.6 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019.

Cost of service sales as a percentage of total net sales increased to 14.1% for the three months ended March 31, 2019, from 13.1% for the three months ended March 31, 2018, primarily due to the reasons provided above.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $11.0 million, or 12.7%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $16.4 million net benefit in 2018 in gains from property insurance claims, partially offset by a $5.7 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019 and savings from cost reduction initiatives. Selling, general and administrative expenses as a percentage of net sales increased from 9.0% for the three months ended March 31, 2018, to 9.7% for the three months ended March 31, 2019, primarily due to the reasons stated above.

Depreciation and Amortization

Depreciation and amortization increased $3.0 million, or 5.3%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, due to a $5.8 million increase in amortization expense primarily related to amortization expense for intangible assets acquired through the Ivie and Periscope acquisitions and the investment in Rise, partially offset by a $2.8 million decrease in depreciation expense from property, plant and equipment becoming fully depreciated over the past year.

Restructuring, Impairment and Transaction-Related Charges

Restructuring, impairment and transaction-related charges decreased $17.3 million, or 69.5%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to the following:

(a) Includes $1.7 million and $5.5 million of impairment charges for machinery and equipment no longer being utilized in production as a result of facility consolidations, as well as other capacity reduction restructuring activities during the three months ended March 31, 2019 and March 31, 2018, respectively, and $2.4 million of land and building impairment charges during the three months ended March 31, 2018.

(b) Includes a $3.5 million gain on the sale of the Hazleton, Pennsylvania facility during the three months ended March 31, 2019, and a $2.2 million gain on the sale of the San Ixhuatepec, Mexico facility during the three months ended March 31, 2018.

EBITDA and EBITDA Margin—Consolidated

EBITDA and EBITDA margin for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, were as follows:

(dollars in millions)

EBITDA decreased $18.8 million for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to the following: (1) lower print volume and pricing due to ongoing industry pressures; (2) a $16.4 million net benefit in 2018 in gains from property insurance claims; and (3) a $5.0 million benefit in 2018 from changes in employee vacation policies. These impacts were partially offset by the following: (1) a $22.3 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019; (2) $17.3 million of decreased restructuring, impairment and transaction-related charges; (3) savings from cost reduction initiatives; and (4) earnings from the Ivie and Periscope acquisitions and the investment in Rise.

EBITDA is defined as net earnings (loss) attributable to Quad common shareholders, excluding (1) interest expense, (2) income tax expense (benefit) and (3) depreciation and amortization. EBITDA margin represents EBITDA as a percentage of net sales. EBITDA and EBITDA margin are presented to provide additional information regarding Quad’s performance. Both are important measures by which Quad gauges the profitability and assesses the performance of its business. EBITDA and EBITDA margin are non-GAAP financial measures and should not be considered alternatives to net earnings (loss) as a measure of operating performance, or to cash flows provided by operating activities as a measure of liquidity. Quad’s calculation of EBITDA and EBITDA margin may be different from the calculations used by other companies, and therefore, comparability may be limited.

A reconciliation of EBITDA to net loss attributable to Quad common shareholders for the three months ended March 31, 2019 and 2018, was as follows:

(dollars in millions)

(1) Net loss attributable to Quad common shareholders included the following:

a. Restructuring, impairment and transaction-related charges of $7.6 million and $24.9 million for the three months ended March 31, 2019 and 2018, respectively;

b. Employee stock ownership plan non-cash expense related to a special employee retirement contribution of $22.3 million for the three months ended March 31, 2018;

c. Net pension income of $1.5 million and $3.1 million for the three months ended March 31, 2019 and 2018, respectively;

d. Loss on debt extinguishment of $15.9 million for the three months ended March 31, 2019;

e. Equity in loss of unconsolidated entity of $0.1 million and equity in earnings of unconsolidated entity of $0.3 million for the three months ended March 31, 2019 and 2018, respectively; and

f. Net loss attributable to noncontrolling interests of $0.3 million for the three months ended March 31, 2019.

United States Print and Related Services

The following table summarizes net sales, operating income, operating margin and certain items impacting comparability within the United States Print and Related Services segment:

(dollars in millions)

56

Net Sales

Product sales for the United States Print and Related Services segment decreased $3.3 million, or 0.5%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $19.4 million decrease in sales in the Company’s print product lines (predominantly due to ongoing volume and pricing pressures from excess capacity in the printing industry), partially offset by a $16.1 million increase in pass-through paper sales.

Service sales for the United States Print and Related Services segment increased $34.2 million, or 21.2%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $42.8 million increase in net sales from the Ivie and Periscope acquisitions and the investment in Rise and a $2.5 million increase in logistics sales, partially offset by a $11.1 million decrease in print management and imaging services.

Operating Income

Operating income for the United States Print and Related Services segment decreased $4.5 million, or 22.2%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to the following: (1) lower print volume and pricing due to ongoing industry pressures; (2) a $16.4 million net benefit in 2018 in gains from property insurance claims; and (3) a $5.0 million benefit in 2018 from the change in employee vacation policies. These impacts were partially offset by the following: (1) a $15.9 million decrease in restructuring, impairment and transaction-related charges; (2) savings from cost reduction initiatives, including employee-related costs; (3) a $21.9 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019; and (4) earnings from the Ivie and Periscope acquisitions and the investment in Rise.

Operating margin for the United States Print and Related Services segment decreased to 1.8% for the three months ended March 31, 2019, compared to 2.3% for the three months ended March 31, 2018, primarily due to the reasons provided above.

Restructuring, Impairment and Transaction-Related Charges

Restructuring, impairment and transaction-related charges for the United States Print and Related Services segment for the three months ended March 31, 2019, were $4.5 million, consisting of the following: (1) $4.1 million of employee termination charges related to workforce reductions through facility consolidations and separation programs; (2) $1.7 million of impairment charges for machinery and equipment no longer being utilized in production as a result of facility consolidations, as well as other capacity reduction restructuring activities; (3) $0.8 million of acquisition-related integration costs primarily related to the integration of acquired companies; and (4) $2.1 million of other restructuring income, including a $3.5 million gain from the sale of the Hazleton, Pennsylvania facility, net of various other restructuring charges to maintain and exit closed facilities.

Restructuring, impairment and transaction-related charges for the United States Print and Related Services segment for the three months ended March 31, 2018, were $20.4 million, consisting of the following: (1) $7.0 million of employee termination charges related to workforce reductions through facility consolidations and separation programs; (2) $5.5 million of impairment charges for machinery and equipment no longer being utilized in production as a result of facility consolidations, as well as other capacity reduction restructuring activities; (3) $0.1 million of acquisition-related integration costs primarily related to the integration of acquired companies; (4) $7.8 million of various other restructuring charges to maintain and exit closed facilities.

International

The following table summarizes net sales, operating income, operating margin, certain items impacting comparability and equity in loss (earnings) of unconsolidated entity within the International segment:

(dollars in millions)

Net Sales

Product sales for the International segment increased $7.3 million, or 7.7%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to an $8.5 million increase in volume, primarily in Peru, and a $6.7 million increase in pass-through paper sales, partially offset by $7.9 million in unfavorable foreign exchange impacts.

Service sales for the International segment decreased $1.0 million, or 19.2%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a decrease in logistics sales in Europe.

Operating Income

Operating income for the International segment decreased $3.8 million, or 66.7%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $3.2 million decrease in operating income, primarily in Europe, Peru and Colombia, and a $0.6 million increase in restructuring, impairment and transaction-related charges.

Restructuring, Impairment and Transaction-Related Charges

Restructuring, impairment and transaction-related charges for the International segment for the three months ended March 31, 2019, were $1.6 million, consisting of $0.3 million of employee termination charges related to workforce reductions through facility consolidations and separation programs and $1.3 million of other restructuring charges, including $1.1 million in charges from foreign currency losses as a result of the economy in Argentina being classified as highly inflationary.

Restructuring, impairment and transaction-related charges for the International segment for the three months ended March 31, 2018, were $1.0 million, consisting of the following: (1) $0.7 million of employee termination charges related to workforce reductions through facility consolidations and separation programs; (2) $2.4 million of impairment charges for land and building; and (3) $2.1 million of various other restructuring income, primarily related to a $2.2 million gain from the sale of the San Ixhuatepec, Mexico facility, partially offset by charges to maintain and exit closed facilities.

Equity in Loss (Earnings) of Unconsolidated Entity

Investments in entities where Quad has the ability to exert significant influence, but not control, are accounted for using the equity method of accounting. The Company holds a 49% ownership interest in Plural, a commercial printer based in São Paulo, Brazil. The equity in loss of unconsolidated entity in the International segment increased $0.4 million for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, due to a decrease in earnings at the Company’s investment in Plural.

Unrestricted Subsidiaries

Unrestricted subsidiaries as defined in the Senior Unsecured Notes indenture represented less than 2.0% of total consolidated net sales for the three months ended March 31, 2019.

Corporate

The following table summarizes unallocated operating expenses presented as Corporate:

(dollars in millions)

Operating Expenses

Corporate operating expenses decreased $4.1 million, or 21.7%, for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $2.0 million decrease in restructuring, impairment and transaction-related charges, a $1.3 million decrease in legal expenses and a $0.4 million non-cash expense related to a special employee retirement contribution in 2018 that did not repeat in 2019.

Restructuring, Impairment and Transaction-Related Charges

Corporate restructuring, impairment and transaction-related charges for the three months ended March 31, 2019, were $1.5 million, consisting of transaction-related charges which primarily included professional service fees.

Corporate restructuring, impairment and transaction-related charges for the three months ended March 31, 2018, were $3.5 million, consisting of the following: (1) $2.9 million of employee termination charges related to workforce reductions through separation programs; (2) $0.7 million of transaction-related charges which primarily included professional service fees; and (3) $0.1 million of other restructuring income.

Liquidity and Capital Resources

The Company utilizes cash flows from operating activities and borrowings under its credit facilities to satisfy its liquidity and capital requirements. At March 31, 2019, the Company had cash and cash equivalents of $10.4 million. In addition to cash and cash equivalents, the Company had $515.6 million of unused capacity under its revolving credit arrangement at March 31, 2019, which was net of $33.7 million of issued letters of credit. The Company believes its expected future cash flows from operating activities, $515.6 million of unused capacity under the revolving credit arrangement and available cash on hand provide sufficient resources to fund ongoing operating requirements and the integration and restructuring requirements related to acquired operations, as well as future capital expenditures, debt and pension service requirements, investments in future growth to create value for its shareholders, shareholder dividends and share repurchases. Borrowings under the $800.0 million revolving credit facility were $250.7 million as of March 31, 2019, and peak borrowings were $350.5 million during the three months ended March 31, 2019.

Net Cash (Used in) Provided by Operating Activities

Three Months Ended March 31, 2019, Compared to Three Months Ended March 31, 2018

Net cash (used in) provided by operating activities decreased $60.8 million, from net cash provided by operating activities of $2.2 million for the three months ended March 31, 2018, to net cash used in operating activities of $58.6 million for the three months ended March 31, 2019. This decrease was due to a $36.1 million decrease in cash flows from changes in operating assets and liabilities, primarily due to the reduction in accounts payable, and a $24.7 million decrease in cash from earnings.

Net Cash Used in Investing Activities

Three Months Ended March 31, 2019, Compared to Three Months Ended March 31, 2018

Net cash used in investing activities increased $77.8 million, from $80.4 million for the three months ended March 31, 2018, to $158.2 million for the three months ended March 31, 2019. The increase was primarily due to the following: (1) a $47.1 million increase from the acquisition of businesses; (2) a $21.1 million increase in purchases of property, plant and equipment; and (3) a $13.1 million decrease in proceeds from property insurance claims. These increases were partially offset by a $3.5 million increase in proceeds from the sale of property, plant, and equipment.

Net Cash Provided by Financing Activities

Three Months Ended March 31, 2019, Compared to Three Months Ended March 31, 2018

Net cash provided by financing activities increased $113.5 million, from $44.2 million for the three months ended March 31, 2018, to $157.7 million for the three months ended March 31, 2019. The increase was primarily due to a $138.8 million increase in net borrowings of debt and lease obligations in 2019 as compared to 2018 and a $0.9 million decrease in equity awards redeemed to pay employees’ tax obligations. These increases were partially offset by the following: (1) a $20.2 million increase in payments of debt issuance costs and financing fees; (2) a $4.0 million decrease in proceeds from stock options exercised; and (3) a $2.0 million increase in payments of cash dividends.

Free Cash Flow

Free Cash Flow is defined as net cash provided by operating activities less purchases of property, plant and equipment, plus LSC-related payments.

The Company’s management assesses Free Cash Flow as a measure to quantify cash available for (1) strengthening the balance sheet (debt reduction), (2) strategic capital allocation and deployment through investments in the business (acquisitions and strategic investments) and (3) returning capital to the shareholders (dividends and share repurchases). The priorities for capital allocation and deployment will change as circumstances dictate for the business, and Free Cash Flow can be significantly impacted by the Company’s restructuring activities and other unusual items.

Free Cash Flow is a non-GAAP financial measure and should not be considered an alternative to cash flows provided by operating activities as a measure of liquidity. Quad’s calculation of Free Cash Flow may be different from similar calculations used by other companies, and therefore, comparability may be limited.

Free Cash Flow for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, was as follows:

(dollars in millions)

(1) LSC-related payments includes the incremental interest payments associated with the 2019 amended debt refinancing and payments for transaction-related costs associated with the proposed acquisition of LSC.

Free Cash Flow decreased $78.6 million for the three months ended March 31, 2019, compared to the three months ended March 31, 2018, primarily due to a $60.8 million decrease in net cash provided by operating activities and a $21.1 million increase in capital expenditures, partially offset by a $3.3 million increase in LSC-related payments. See the “Net Cash Provided by Operating Activities” section above for further explanations of the change in operating cash flows and the “Net Cash Used in Investing Activities” section above for further explanations of the changes in purchases of property, plant and equipment.

Debt Leverage Ratio

The Debt Leverage Ratio is defined as total debt and finance lease obligations divided by the trailing twelve months Adjusted EBITDA, comprised of the sum of the following: (1) the last twelve months of EBITDA (see the definition of EBITDA and the reconciliation of net earnings (loss) attributable to Quad common shareholders to EBITDA in the “Results of Operations” section above); (2) restructuring, impairment and transaction-related charges; (3) net pension income; (4) employee stock ownership plan contribution; (5) loss (gain) on debt extinguishment; (6) equity in (earnings) loss of unconsolidated entity; (7) Adjusted EBITDA for unconsolidated equity method investments (calculated in a consistent manner with the calculation for Quad); and (8) net earnings (loss) attributable to noncontrolling interests.

The Company uses the Debt Leverage Ratio as a metric to assess liquidity and the flexibility of its balance sheet. Consistent with other liquidity metrics, the Company monitors the Debt Leverage Ratio as a measure to determine the appropriate level of debt the Company believes is optimal to operate its business, and accordingly, to quantify debt capacity available for strategic capital allocation and deployment through investments in the business (capital expenditures, acquisitions and strategic investments), for strengthening the balance sheet (pension liability reduction), and for returning capital to the shareholders (dividends and share repurchases). The priorities for capital allocation and deployment will change as circumstances dictate for the business, and the Debt Leverage Ratio can be significantly impacted by the amount and timing of large expenditures requiring debt financing, as well as changes in profitability.

The Debt Leverage Ratio is a non-GAAP measure and should not be considered an alternative to cash flows provided by operating activities as a measure of liquidity. Quad’s calculation of the Debt Leverage Ratio may be different from similar calculations used by other companies and, therefore, comparability may be limited.

The Debt Leverage Ratio calculated below differs from both the total leverage ratio and the senior secured leverage ratio included in the Company’s debt covenant calculations (see Note 9, “Debt,” to the condensed consolidated financial statements in Item 1, “Condensed Consolidated Financial Statements (Unaudited),” of this Quarterly Report on Form 10-Q for further information on debt covenants). The total leverage ratio included in the Company’s debt covenants includes letters of credit and surety bonds as debt, excludes non-cash stock-based compensation expense from EBITDA and includes the equity in (earnings) loss of unconsolidated entity, the Adjusted EBITDA for unconsolidated equity method investments and net income (loss) attributable to noncontrolling interests in EBITDA. Similarly, the senior secured leverage ratio included in the Company’s debt covenants includes and excludes the same adjustments as the total leverage ratio, in addition to the exclusion of the outstanding balance of the Senior Unsecured Notes, surety bonds and domestic unrestricted cash.

The Debt Leverage Ratio at March 31, 2019, and December 31, 2018, was as follows:

(dollars in millions)

(1) As permitted by the Company’s senior secured credit facility, certain pro forma financial information related to the acquisitions of Periscope and Ivie were included in calculating the Debt Leverage Ratio as of March 31, 2019, and December 31, 2018:

(a) As the acquisition of Periscope was completed on January 3, 2019, the $7.8 million pro forma Adjusted EBITDA represents the period from April 1, 2018, to January 2, 2019. Adjusted EBITDA for Periscope was calculated in a consistent manner with the calculation above for Quad. Periscope’s financial information has been consolidated within Quad’s financial results since the date of acquisition. If the nine months of pro forma Adjusted EBITDA for Periscope was not included in the calculation, the Company’s Debt Leverage Ratio would have been 3.05x as of March 31, 2019.

(b) As the acquisition of Ivie was completed on February 21, 2018, the $2.9 million pro forma Adjusted EBITDA represents the period from January 1, 2018, to February 20, 2018. Adjusted EBITDA for Ivie was calculated in a consistent manner with the calculation above for Quad. Ivie’s financial information has been consolidated within Quad’s financial results since the date of acquisition. If the two months of pro forma Adjusted EBITDA for Ivie was not included in the calculation, the Company’s Debt Leverage Ratio would have been 2.27x as of December 31, 2018.

(2) The Company had $70 million in cash and cash equivalents at December 31, 2018. Based on the Company’s typical year-end cash balance of approximately $10 million, Quad had $60 million of excess cash at December 31, 2018. If the excess cash was used to further pay down debt, the Debt Leverage Ratio would have been 2.11x at December 31, 2018.

The calculation of Adjusted EBITDA for the trailing twelve months ended March 31, 2019, and December 31, 2018, was as follows:

(1) Financial information for the year ended December 31, 2018, is included as reported in the Company’s 2018 Annual Report on Form 10-K filed with the SEC on February 20, 2019.

(2) Other is comprised of equity in loss (earnings) of unconsolidated entity, Adjusted EBITDA for unconsolidated equity method investments and net earnings (loss) attributable to noncontrolling interests.

The Debt Leverage Ratio, net of excess cash, as of December 31, 2018, increased 0.88x at March 31, 2019, compared to December 31, 2018, primarily due to a $200.9 million increase in debt and finance lease obligations, primarily related to the cash paid for the Periscope acquisition and a $21.1 million increase in purchases of property, plant and equipment. The Debt Leverage Ratio at March 31, 2019, of 2.99x is above management’s desired target Debt Leverage Ratio range of 2.0x to 2.5x; however, the Company operates at times above the Debt Leverage Ratio target range depending on the timing of compelling strategic investment opportunities like the Periscope acquisition and proposed acquisition of LSC, as well as seasonal working capital needs.

Debt Obligations

The Company completed the third amendment to the April 28, 2014 Senior Secured Credit Facility on January 31, 2019. This third amendment was completed to provide Quad with the liquidity and structural flexibility to consummate the proposed acquisition of LSC and to extend existing maturities by (a) increasing the aggregate amount of the existing revolving credit facility from $725.0 million to $800.0 million in two tranches, with the first tranche of approximately $82.8 million maturing on January 4, 2021, and the second tranche of approximately $717.2 million, with a term of five years, maturing on January 31, 2024; (b) increasing the aggregate amount of the existing Term Loan A from $375.0 million to $825.0 million in two tranches, with the first tranche of approximately $32.4 million maturing on January 4, 2021, and the second tranche of approximately $792.6 million, with a delayed draw feature and term of five years, maturing on January 31, 2024; and (c) increasing the aggregate amount of the existing Term Loan B from $300.0 million to $500.0 million with a term of seven years, maturing on January 31, 2026. The Company intends that the loans available under the amended revolving credit facility will be used to repay, refinance, repurchase, redeem, exchange or otherwise terminate LSC’s existing indebtedness prior to, in connection with or following the consummation of the merger, and to pay transaction expenses. The amendment resulted in a loss on debt extinguishment of $15.9 million during the three months ended March 31, 2019. In addition, certain amendments were made to the quarterly financial covenants to which the Company is subject (all financial terms, numbers and ratios are as defined in the Senior Secured Credit Facility, as amended by the third amendment).

Borrowings under the revolving credit facility and delayed draw Term Loan A made under the Senior Secured Credit Facility will initially bear interest at 2.50% in excess of reserve adjusted LIBOR, or 1.50% in excess of an alternate base rate, and borrowing under the Term Loan B will initially bear interest at 5.00% in excess of reserve adjusted LIBOR, or 4.00% in excess of an alternative base rate at the Company’s option.

The Senior Secured Credit Facility remains secured by substantially all of the unencumbered assets of the Company. The Senior Secured Credit Facility also requires the Company to provide additional collateral to the lenders in certain limited circumstances. See Note 9, “Debt,” to the condensed consolidated financial statements in Item 1, “Condensed Consolidated Financial Statements (Unaudited),” of this Quarterly Report on Form 10-Q for additional information.

As of March 31, 2019, the Company utilized a combination of debt instruments to fund cash requirements, including the following:

• Senior Secured Credit Facility:
• Revolving credit facility ($250.7 million outstanding as of March 31, 2019);
• Term Loan A ($32.4 million outstanding as of March 31, 2019); and
• Term Loan B ($485.4 million outstanding as of March 31, 2019);
• Senior Unsecured Notes ($243.5 million outstanding as of March 31, 2019); and
• Master Note and Security Agreement ($94.4 million outstanding as of March 31, 2019).

Covenants and Compliance

The Company’s various lending arrangements include certain financial covenants (all financial terms, numbers and ratios are as defined in the Company’s debt agreements). Among these covenants, the Company was required to maintain the following as of March 31, 2019:

• Total Leverage Ratio. On a rolling twelve-month basis, the total leverage ratio, defined as total consolidated debt to consolidated EBITDA, shall not exceed 3.75 to 1.00 (for the twelve months ended March 31, 2019, the Company’s total leverage ratio was 2.90 to 1.00).
• Liquidity. The Company is required to maintain liquidity, defined as unrestricted cash and permitted investments of the Company and its subsidiaries (subject to certain conditions) plus the aggregate amount of the unused revolving credit facility commitments, of not less than $300.0 million at any time during the period from six months prior to the maturity date of the Company’s Senior Unsecured Notes until the earlier of the date on which (a) such Senior Unsecured Notes are repaid in full or (b) the maturity date of such Senior Unsecured Notes is extended to a date that is at least 91 days later than the latest maturity date under the Senior Secured Credit Facility. The maturity date of the Company’s Senior Unsecured Notes is currently May 1, 2022. As of March 31, 2019, the liquidity covenant is not applicable, as the Company is not within the six month period prior to the May 1, 2022, maturity date of the Senior Unsecured Notes.
• If there is any amount outstanding on the Revolving Credit Facility or Term Loan A, or if any lender has any revolving credit exposure or Term Loan A credit exposure, the Company is required to maintain the following:
• Senior Secured Leverage Ratio. On a rolling twelve-month basis, the senior secured leverage ratio, defined as senior secured net debt to consolidated EBITDA, shall not exceed 3.50 to 1.00 (for the twelve months ended March 31, 2019, the Company’s senior secured leverage ratio was 2.26 to 1.00).
• Interest Coverage Ratio. On a rolling twelve-month basis, the interest coverage ratio, defined as consolidated EBITDA to consolidated cash interest expense, shall not be less than 3.00 to 1.00 (for the twelve months ended March 31, 2019, the Company’s interest coverage ratio was 5.38 to 1.00).

The indenture underlying the Senior Unsecured Notes contains various covenants, including, but not limited to, covenants that, subject to certain exceptions, limit the Company’s and its restricted subsidiaries’ ability to incur and/or guarantee additional debt; pay dividends, repurchase stock or make certain other restricted payments; enter into agreements limiting dividends and certain other restricted payments; prepay, redeem or repurchase subordinated debt; grant liens on assets; enter into sale and leaseback transactions; merge, consolidate, transfer or dispose of substantially all of the Company’s consolidated assets; sell, transfer or otherwise dispose of property and assets; and engage in transactions with affiliates.

The Company was in compliance with all financial covenants in its debt agreements as of March 31, 2019. While the Company currently expects to be in compliance in future periods with all of the financial covenants, there can be no assurance that these covenants will continue to be met. The Company’s failure to maintain compliance with the covenants could prevent the Company from borrowing additional amounts and could result in a default under any of the debt agreements. Such default could cause the outstanding indebtedness to become immediately due and payable, by virtue of cross-acceleration or cross-default provisions.

In addition to those covenants, the Senior Secured Credit Facility also includes certain limitations on acquisitions, indebtedness, liens, dividends and repurchases of capital stock, including the following:

• If the Company’s total leverage ratio is greater than 2.75 to 1.00 (as defined in the Senior Secured Credit Facility), the Company is prohibited from making greater than $120.0 million of annual dividend payments, capital stock repurchases and certain other payments. If the total leverage ratio is less than 2.75 to 1.00, there are no such restrictions. As the Company’s total leverage ratio as of March 31, 2019, was 2.90 to 1.00, the limitations described above are currently applicable.
• If the Company’s senior secured leverage ratio is greater than 3.00 to 1.00 or the Company’s total leverage ratio is greater than 3.50 to 1.00 (these ratios as defined in the Senior Secured Credit Facility), the Company is prohibited from voluntarily prepaying any of the Senior Unsecured Notes and from voluntarily prepaying any other unsecured or subordinated indebtedness, with certain exceptions (including any mandatory prepayments on the Senior Unsecured Notes or any other unsecured or subordinated debt). If the senior secured leverage ratio is less than 3.00 to 1.00 and the total leverage ratio is less than 3.50 to 1.00, there are no such restrictions.

Risk Management

For a discussion of the Company’s exposure to market risks and management of those market risks, see Item 3, “Quantitative and Qualitative Disclosures About Market Risk,” of this Quarterly Report on Form 10-Q.

Contractual Obligations and Off-Balance Sheet Arrangements

As of March 31, 2019, other than the impact to the Company’s future debt obligations resulting from the completion of the third amendment to the April 28, 2014 Senior Secured Credit Facility on January 31, 2019, the Company’s contractual obligations and off-balance sheet arrangements have not changed materially from that listed in the “Contractual Obligations and Other Commitments” table and related notes to the table listed in the Company’s Annual Report on Form 10-K filed on February 20, 2019. See Note 9, “Debt,” to the condensed consolidated financial statements in Item 1, “Condensed Consolidated Financial Statements (Unaudited),” of this Quarterly Report on Form 10-Q) for more information on the Company’s debt obligations.

New Accounting Pronouncements

See Note 21, “New Accounting Pronouncements,” to the condensed consolidated financial statements in Item 1, “Condensed Consolidated Financial Statements (Unaudited),” of this Quarterly Report on Form 10-Q.

The Company is exposed to a variety of market risks which may adversely impact the Company’s results of operations and financial condition, including changes in interest and foreign currency exchange rates, changes in the economic environment that would impact credit positions and changes in the prices of certain commodities. The Company’s management takes an active role in the risk management process and has developed policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks. These risk management strategies may not fully insulate the Company from adverse impacts due to market risks.

Interest Rate Risk

The Company is exposed to interest rate risk on variable rate debt obligations and price risk on fixed rate debt and finance leases. The variable rate debt outstanding at March 31, 2019, was primarily comprised of $250.7 million outstanding on the revolving credit facility, $32.4 million outstanding on the Term Loan A and $485.4 million outstanding on the Term Loan B. In order to reduce the variability of cash flows from interest payments related to a portion of Quad’s variable-rate debt, the Company entered into a $250.0 million interest rate swap during February 2017 and a $130.0 million interest rate swap during March 2019, and has classified $380.0 million of the Company’s variable rate debt as fixed rate debt. Including the impact of the $380.0 million interest rate swap of variable rate to fixed rate debt, Quad had variable rate debt outstanding of $389.7 million at a current weighted average interest rate of 5.4% and fixed rate debt and finance leases outstanding of $752.1 million at a current weighted average interest rate of 6.9% as of March 31, 2019. A hypothetical 10% increase in the market interest rates impacting the Company’s current weighted average interest rate on variable rate debt obligations would not have a material impact on the Company’s interest expense. A hypothetical 10% change in market interest rates would change the fair value of fixed rate debt at March 31, 2019, by approximately $7 million.

Foreign Currency Risk and Translation Exposure

The Company is exposed to the impact of foreign currency fluctuations in certain countries in which it operates. The exposure to foreign currency movements is limited in most countries because the operating revenues and expenses of its various subsidiaries and business units are substantially in the local currency of the country in which they operate. To the extent revenues and expenses are not in the applicable local currency, the Company may enter into foreign exchange forward contracts to hedge the currency risk.

Although operating in local currencies may limit the impact of currency rate fluctuations on the results of operations of the Company’s non-United States subsidiaries and business units, rate fluctuations may impact the consolidated financial position as the assets and liabilities of its foreign operations are translated into United States dollars in preparing the Company’s condensed consolidated balance sheets. As of March 31, 2019, the Company’s foreign subsidiaries (excluding Argentina due to the economy’s status as highly inflationary) had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of $32.4 million. The potential decrease in net current assets as of March 31, 2019, from a hypothetical 10% adverse change in quoted foreign currency exchange rates, would be approximately $3.2 million. This sensitivity analysis assumes a parallel shift in all major foreign currency exchange rates versus the United States dollar. Exchange rates rarely move in the same direction relative to the United States dollar due to positive and negative correlations of the various global currencies. This assumption may overstate or understate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency.

The Company’s hedging operations have historically not been material, and gains or losses from these operations have not been material to the Company’s results of operations, financial position or cash flows. The Company does not use derivative financial instruments for trading or speculative purposes.

These international operations are subject to risks typical of international operations, including, but not limited to, differing economic conditions, changes in political climate, potential restrictions on the movement of funds, differing tax structures, and other regulations and restrictions. Accordingly, future results could be adversely impacted by changes in these or other factors.

The Company has considered the economy in Argentina to be highly inflationary, effective June 30, 2018. In accordance with ASC 830 — Foreign Currency Matters, a highly inflationary economy is one that has experienced cumulative inflation of approximately 100 percent or more over a three-year period. An entity is required to apply the revised accounting guidance in the reporting period following when the economy was deemed to be highly inflationary. As a result of this classification, the functional currency of the Company’s Argentina Subsidiaries was changed from the local currency to the United States Dollar, beginning July 1, 2018, and impacts from the change in the value of the local currency for monetary assets and liabilities is now reflected in the condensed consolidated statements of operations. The total impact from foreign currency losses was $1.1 million during the three months ended March 31, 2019. The Company’s operations in Argentina represented less than 2.0% of total consolidated assets as of March 31, 2019, and less than 2.0% of total consolidated net sales for the three months ended March 31, 2019.

Credit Risk

Credit risk is the possibility of loss from a customer’s failure to make payments according to contract terms. Prior to granting credit, each customer is evaluated in an underwriting process, taking into consideration the prospective customer’s financial condition, past payment experience, credit bureau information and other financial and qualitative factors that may affect the customer’s ability to pay. Specific credit reviews and standard industry credit scoring models are used in performing this evaluation. Customers’ financial condition is continuously monitored as part of the normal course of business. Some of the Company’s customers are highly leveraged or otherwise subject to their own operating and regulatory risks. Based on those customer account reviews and due to the continued uncertainty of the global economy, the Company has established an allowance for doubtful accounts of $28.0 million as of March 31, 2019, and $27.6 million as of December 31, 2018.

The Company has a large, diverse customer base and does not have a high degree of concentration with any single customer account. During the three months ended March 31, 2019, the Company’s largest customer accounted for less than 5% of the Company’s net sales. Even if the Company’s credit review and analysis mechanisms work properly, the Company may experience financial losses in its dealings with customers and other parties. Any increase in nonpayment or nonperformance by customers could adversely impact the Company’s results of operations and financial condition. Economic disruptions could result in significant future charges.

Commodity Risk

The primary raw materials that Quad uses in its print business are paper, ink and energy. At this time, the Company’s supply of raw materials is readily available from numerous vendors; however, based on market conditions, that could change in the future. The Company generally buys these raw materials based upon market prices that are established with the vendor as part of the procurement process.

Approximately half of the paper used in the printing process is supplied directly by the Company’s clients. For those clients that do not directly supply their own paper, the Company makes use of its purchasing efficiencies to supply paper by negotiating with leading paper vendors, uses a wide variety of paper grades, weights and sizes, and does not rely on any one vendor. In addition, the Company generally includes price adjustment clauses in sales contracts for paper and other critical raw materials in the printing process. Although these clauses generally mitigate paper price risk, higher paper prices and tight paper supplies, as well as changes in the United States import or trade regulations may have an impact on client demand for printed products. The Company’s working capital requirements, including the impact of seasonality, are partially mitigated through the direct purchasing of paper by its clients.

The Company produces the majority of ink used in its print production, allowing it to control the quality, cost and supply of key inputs. Raw materials for the ink manufacturing process are purchased externally from a variety of vendors.

The Company generally cannot pass on to clients the impact of higher electric and natural gas energy prices on its manufacturing costs, and increases in energy prices result in higher manufacturing costs for certain of its operations. The Company mitigates its risk through natural gas hedges when appropriate. In its logistic operations, however, the Company is able to pass a substantial portion of any increase in fuel prices directly to its clients.

As a result, management believes a hypothetical 10% change in the price of paper and other raw materials would not have a significant direct impact on the Company’s consolidated annual results of operations or cash flows; however, significant increases in commodity pricing or tight supply could influence future client demand for printed products.

Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report and has concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

During the fiscal quarter ended March 31, 2019, the Company modified certain processes and implemented new or revised existing controls as part of its efforts to adopt the new leasing standard (Topic 842), which became effective on January 1, 2019. The operating effectiveness of these changes will be evaluated with the annual assessment of internal control over financial reporting for the year ended December 31, 2019. There were no other changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the fiscal quarter ended March 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Risk factors relating to the Company are contained in Item 1A, “Risk Factors,” of the Company’s 2018 Annual Report on Form 10-K, filed with the SEC on February 20, 2019. No material changes to such risk factors occurred during the period from January 1, 2019, through March 31, 2019.