By Jan Stoddard of Raine Consulting July 30, 2003 - Quebecor World Inc. (NYSE; TSX: IQW) announced that for the second quarter 2003, the Company recorded a loss of $62 million or ($0.51) per share after impairment of assets, restructuring and other charges of $82 million. This compares to earnings of $64 million or $0.40 per share in the second quarter of last year. Before this charge Quebecor World recorded a loss of $0.07 per share. Consolidated revenues for the quarter were essentially flat compared to same period last year at $1.5 billion. Editor's Note: Even though revenues were up slightly (primarily due to currency exchange) and QW incurred a $62 million loss in the second quarter; cash flow is still positive. But all the other news was agonizing. Unforeseen by analysts, Quebecor World plummeted from a $64 million same quarter profit last year to a $63 million dollar loss. Operating profit at Quebecor World's North American division slumped to $45.3 million from $124.0 million a year earlier. Most of the loss was due to a large restructuring charge related to the termination of another 1,000 employees, elimination of idle and obsolete assets dating back to the World Color acquisition, and hedging against upcoming bad customer debt. However, even with full capacity for Fall schedules in North America, will it be enough to counter what COO David Boles describes as "irrational pricing behavior?" The second half of 2003 is proving to be make-or-break time for all printers, large and small. Quebecor World's quarterly earnings call and web cast, was conducted by Mr. Jean Neveu, President and CEO; Mr. Claude Helie, Exec VP and CFO; and, Mr. David Boles, COO, Quebecor World North America. Call Topics: * CEO Comments * Financial Reporting * North American Market Update * Q&A CEO Comments Mr. Jean Neveu, President and CEO, Quebecor World Inc. opened the call by announcing a new initiative to address adverse market conditions of the past two years, stating it was "underway as we speak." The initiative will contribute savings of $306 million per year (or $0.20 per share savings). The savings are coming mostly from the elimination of 1,000 employees. At the last meeting in April, the Chairman of Quebecor World (QW) announced a strong new governance policy designed to ensure timely disclosure of revenue information. This imposes rigorous demands on management to identify, resolve and be accountable for any significant issue or problem. It is within this context, that the announcement of this restructuring was made today. The impairment of restructuring and other charges of $82 million contributed to loss of $0.51 per share for the second quarter. Excluding this charge, the loss per share was $0.07. Further reduction of price per share by $0.27 resulted from other specific charges. Consolidated revenues were $1.5 billion (essentially flat). Neveu noted, "External factors include issues we have talked about before; price erosion from over-capacity, weak demand for advertising, steadily increasing or rising employee costs, and higher energy costs. In summarizing, this continues to be a very difficult environment for printers and our results reflect this." Financial Reporting Mr. Claude Helie, Executive VP and CFO, then remarked that, "Until recently the economic conditions affecting our financial results were somewhat contained to isolated geographies or products. This is no longer the case as we are now experiencing pressures in almost all divisions." During the second quarter, consolidated revenues increased 2%, but adjusting for currency impact of $65 million, revenues were down slightly. Operating income was $43 million before impairment, restructuring and other charges. * North America: In North American, revenues were stable revenue for the quarter at $1.2 billion due to winning new business and renewing long-term contracts. Operating income was $45.3 million compared to $125 million last year. The North American performance reflects the price concessions made to customers to build volume and long-term relationships resulting from overall reduced print and advertising demand. The ad industry posted 1% decline in ad pages for the quarter and was particularly weak in June being down 3%. QW is feeling the impact of other increases such as energy and employee benefit costs. In North America, $15 million charges related to the logistics business was also recorded and increased the provision for doubtful accounts (bad debt) by $11 million. * Europe: Revenues in Europe increased 12% to $268 million U.S., but expressed in Euros, sales were at €236 million versus €261 million last year. (Although the currency translation benefits were a significant factor in this quarter's slight increase in overall consolidated revenues.) Operating income was $3.4 million versus $8.3 million (U.S. $) last year. The European print market continues to suffer from overcapacity affecting both volume and pricing. Business in the UK, Belgium and Austria performed well during the quarter but difficult market conditions in France, Spain and the Nordic countries have had a negative impact on overall results. A new Managing Director of Operations for France was appointed. * Latin America: Latin American revenues were stable at $44 million while operating income was negative $3.5 million for the quarter, reflecting a weak pricing environment, excess print capacity in the region, and a difficult economic environment. Also included was a specific charge of $4.4 million to increase accounts receivables and other items. Helie then reviewed the quarter's $82 million in restructuring charges and other specific charges impacting the price per share. Restructuring: Helie noted that in a review of last year's restructuring, QW did not go far enough resulting in the announced additional reduction of 1,000 employees. (Note: 3,000 job cuts were made last year when the company closed 10 plants to counter weak advertising markets and overcapacity in the printing industry.) More than half of the positions are in North America, noting that 100 eliminated jobs were from Canada (25 of those being in Quebec). As of today, 750 positions have already been eliminated. Costs associated with these new reductions are expected to be approximately $26 million; of which $23 million will be in cash. Half of these savings should be realized in 2003. Additional charges of $8 million were required to complete previous years' restructuring initiatives. This restructuring also included a $47 million in asset write-off resulting from the consolidation of World Color and Quebecor operations that created a collection of idle, obsolete presses and other equipment. It is these assets that have been identified for disposal. An additional $49 million of specific charges were taken relating to accounts receivables and logistics business. Helie noted that the QW Logistics business is the largest shipper of product by volume into the U.S. Postal System. (In three years, it has gone from shipping 1.7 billion tons of printed products annually to an expected 4.5 billion tons by 2003.) This resulted in a $15 million adjustment related to rapid growth and systems issues. Helie also noted that the Logistics Business is now under new management. Bad debt provision increased by $15 million as Helie noted that Chapter 7 filings in the U.S. have increased by 5% in the first quarter (up 10% from same quarter last year). Additionally, there was $19 million taken of various adjustments of less than $2.5 million such as the write down of other assets, inventories and spare parts. The specific charges totaled $49 million or earnings per share impact of $0.47. In the second quarter 2003, the Company generated $72 million of free cash flow compared to $40 million of free cash flow in the same quarter last year. Long-term debt increased by $164 million for the quarter, primarily due to the repurchase of 10 million shares announced last quarter. North American Market Update Mr. David Boles, COO, Quebecor World North America, noted that the global economy is challenged, prices are depressed and volumes are being reduced. In discussing how to reduce costs for lower price levels, Boles presented a multi-faceted plan including: 1) Reduced discretionary spending (travel, meetings), 2) Re-organized management structure in North American (from 25 direct reports to 12, from 11 Group Presidents to 7), Group Presidents are now responsible for both Sales and Manufacturing, 8) Book and Directory Operations, Book and Catalog, and Commercial, Direct and Pre-Media Businesses now report to one Group President, 9) Infrastructure functions have been centralized (Purchasing, Accounting, and Human Resources), 10) Consolidated regional purchasing for multiple plants and supplier reduction (from 300 to 20 suppliers for pallets and shrink-wrap), 11) Best Practices have been initiated citing the Gravure Process Optimization Team working across 13 gravure operations to identify savings, 12) Capital driven. Boles commented that QW was competing aggressively and successfully in the current pricing environment. However, Boles emphatically stated, "But, there is no free lunch. I will not take work at any price. If we can't make money at it, and there are not a lot of strategic reasons for doing so, we will and have walked away. Sure, we have signed long-term contracts and lowered prices to maintain relationships and to secure the business, but only if we because we truly believed that we can reduce the costs and maintain acceptable margins for our stockholders." Product Group Performance: * In the Magazines product group, Boles stated that QW is renewing major contracts and gaining the lion's share of new launches from Hearst, CondeNast and other major publishers. Recently awarded was "Motor News," printed by a competitor for thirty years, due to reduced cycle time and new revenue generation ideas. Some customers are increasing volumes. They will continue their current partnership strategy. * The Book product group continues to be unable to offset the impact from volume and pricing reductions (Harry Potter and Hillary Clinton's titles were the exceptions). Reductions in workforce have taken place in Brazil and Kingsport. Kingsport (accounts for more that 80% of EBIT fallout) will become a more specialized facility. * In the Directories product group, they have experienced reduced run lengths and advertiser's reducing ads. They have signed $70 million long-term contract with Yellow Book and Verizon Canada. * The Commercial marketplace is beginning to gain momentum, but pricing remains depressed. Currently, they are making money at all facilities and have seen volumes rebound in July and August. * Retail is a tough market although they have seen quarter-over-quarter improvements especially in the offset platform. The new offset facility in Riverside, CA has had start-up problems. * The Canadian market has been impacted by the appreciation of the Canadian dollar. Pricing has been difficult, but QW has had contract renewals and new business with Toys-R-Us, Home Depot Canada, Shoppers Drug Market, and Columbia House. Cross-selling initiatives are underway to show customers how to use QW technology to develop: new direct mail initiatives such as scratch-offs or loyalty cards, to help college textbook publishers sell more new than used textbooks, and in-store events to promote children's magazines (children's publishers and retailers). Boles also announced a Board decision of a $12.8 million investment in education book market (i.e. a long-term enabling contract with McGraw-Hill to give 1/3 of all their educational products). QW will be relocating and upgrading an existing plant in Dubuque, Iowa and will move from soft-cover to the largest producer of 10 7/8" hard-cover educational textbooks. International Update Latin America markets continue to show weakness, with largest price erosion in Columbia. Exports to Mexico and the U.S. from Latin America are up 20% over last year. Europe is also suffering from weak markets and weak pricing. In Germany, the weak market is one of the major roadblocks in the return to stable pricing. Sweden, Finland and Spain are also challenged markets. Q & A 1. The $5 million SG&A adjustment (this quarter versus last year) efforts will continue. One-half of the savings from the $36 million reduction should be realized in second half of this year. "When we bought shares, we said it would increase annual benefits by $0.10 per share. We are putting in place many measures to impact second half results, but will not forecast it. We expect the second half performance to be the same as last year's results." 2. January 1st, 2003 was a watershed time in terms of contract renewals (more so for QW than other printers). Boles stated that the "number of renewals has been on the high side, others are coming up, but they are not on the same magnitude. Have we hit the trough? Spot pricing is out there and other pricing opportunities are out there but not influenced by long-term contracts. The worst of it is behind us and we are dealing with the lag." 3. Organic revenue growth, excluding paper, was slightly down (about 2%). 4. The functional job loss was in various plants across the organization with no specific departments targeted. 5. Order run lengths dramatically decreased. They have seen order quantities half of what they were just over the last three years. Excess equipment causing price pressures. Strategy continues to be Number One across all segments. 6. In terms of demand, QW expects to be sold out. Pricing is harder to quantify. Boles states, "There is totally irrational behavior out there (maybe coming from the #5 and #6 printers). People are choosing to take anything to keep the presses going, regardless of contribution." QW can not categorize either spot or long-term markets. Customers are recognizing that some prices being put forward may mean that the supplier may not be around in the years forward. Customers are looking to the supply chain consolidators like Quebecor World. 7. Restructuring write-downs were attributed primarily to North America with $49 million specific charges, $4.4 million in Latin America, and several millions for Europe. 8. No revenue guidance was given other than comments previously mentioned above per specific product groups. 9. Neveu believes that they have taken out enough capacity to 'right size' the business. QW does not know of any other large write-offs in the coming quarter. 10. Unit volume (from a North American perspective during peak periods) is not the problem this year. Break-evens have dropped, seasonality (more acute this year), and sufficient capacity utilization will impact the ability to reach the 9-10% EBIT model. Boles also noted that reducing industry capacity will affect irrational pricing behavior. 11. QW does not see any structural risks in Europe, and if needed, QW will make changes quickly citing Spain and Sweden. Part of Spain is doing well; the other part is a volume problem. Sweden operations, purchased three years ago, are not the same context as France. 12. Charges related to the logistics business were related simply to the business growing rapidly and what QW needed to do to catch-up in terms of systems. (This was not related specifically just to this quarter, but past quarters as well.) 13. When asked about his future plans, CEO Jean Neveu said, "He would be here as long as he needed to be here." Jan Stoddard is an Associate at Raine Consulting and can be reached at [email protected].