LSC COMMUNICATIONS, INC. The following discussion ofLSC Communications' financial condition and results of operation should be read together with the consolidated financial statements and Notes to those statements included in Item 15, Exhibits, Financial Statement Schedules, of Part IV of this annual report on Form 10-K. Business
For a description of the Company's business, segments and product offerings, refer to Item 1, Business, of Part I of this annual report on Form 10-K.
Merger Agreement OnOctober 30, 2018 , the Company entered into that certain Agreement and Plan of Merger (the "Merger Agreement"), by and among Quad/Graphics, Inc. ("Quad"),QLC Merger Sub, Inc. andLSC Communications , pursuant to which, subject to the satisfaction or waiver of certain conditions,LSC Communications would be merged withQLC Merger Sub, Inc. , and become a wholly-owned subsidiary of Quad. OnJuly 22, 2019 ,Quad andLSC Communications entered into a letter agreement (the "Letter Agreement"), pursuant to which the parties agreed to terminate the Merger Agreement. Pursuant to the Letter Agreement, Quad agreed to payLSC Communications the Regulatory Approval Reverse Termination Fee (as defined in the Merger Agreement) of$45 million in cash on the business day following the date of the Letter Agreement. The Company incurred transaction costs of approximately$26 million associated with the Merger Agreement, of which$5 million was incurred in 2018. Except for certain indemnification obligations of Quad related toLSC Communications assisting Quad with the financing under the Merger Agreement, the parties also agreed to release each other from any and all claims, counterclaims, demands, proceedings, actions, causes of action, orders, obligations, damages, debts, costs, expenses and other liabilities whatsoever and howsoever arising pursuant to or in connection with the Merger Agreement or the transactions provided for in the Merger Agreement. Segment Information As a result of the Company's segment analysis in the fourth quarter of 2019,Mexico met the requirements to be classified as a reportable segment (previously included as a non-reportable segment). All prior year amounts have been reclassified to conform to the Company's current reporting structure. OUTLOOK Vision and Strategy The Company works with its customers to offer a broad scope of print and print-related capabilities and manage their full range of communication needs. The Company is focused on enhancing its strong customer relationships by expanding to a broader range of offerings. The Company will focus on further expanding its supply chain offerings and driving growth in core and related businesses. The Company will continue to seek opportunities to grow by utilizing core capabilities to expand print and print-related products and services, grow core businesses, strategically increase our geographic coverage, and focus on the expansion of the office products brands. For instance, our end-to-end supply chain services offerings combine print, warehousing, fulfillment and supply chain management into a single workflow designed to increase speed to the market and improve efficiencies across the distribution process. Further, other innovative offerings and investments such as co-mailing services and logistics solutions help catalogers and magazine publishers reduce their overall cost of producing and distributing their product as postage expense often accounts for approximately half of these publishers' costs to produce and deliver a catalog or magazine. We have also developed and deployed technologies to help book clients reduce the incidence of book piracy and have begun offering end-to-end fulfillment of subscription boxes to address client demand, which we believe will provide additional opportunity for us. Management believes productivity improvement and cost reduction are critical to the Company's continued competitiveness, and the flexibility of its platform enhances the value the Company delivers to its customers. Our plant rationalization process has resulted in the closure of several facilities in recent years, which we believe has allowed us to realize meaningful cost savings. These 28 -------------------------------------------------------------------------------- cost savings primarily arise from facility related costs, such as overhead, employee costs and selling, general and administrative expenses. The Company continues to implement strategic initiatives across all platforms to reduce its overall cost structure, focus on safety initiatives and enhance productivity, including restructuring, consolidation, reorganization and integration of operations and streamlining of administrative and support activities.
The Company seeks to deploy its capital using a balanced and disciplined approach. Priorities for capital deployment, over time, include principal and interest payments on debt obligations, targeted acquisitions and capital expenditures. The Company believes that a strong financial condition is important to customers focused on establishing or growing long-term relationships.
Management uses several key indicators to gauge progress toward achieving these objectives. These indicators include organic sales growth, operating margins, cash flow from operations, capital expenditures, and Non-GAAP adjusted EBITDA.The Company targets long-term net sales growth at or above industry levels, while managing operating margins by achieving productivity improvements that offset the impact of price declines and cost inflation. Cash flows from operations are targeted to be stable over time, however, cash flows from operations in any given year can be significantly impacted by the timing of non-recurring or infrequent receipts and expenditures, volatility in the cost of raw materials, and the impact of working capital management efforts. During late 2018 and early 2019, the Company performed a comprehensive review of the Company's operations to identify new revenue opportunities and cost savings. This review covered substantially all aspects of the Company - both operational and support functions - and involved key personnel from throughout the organization. The resulting revenue opportunities and cost savings initiatives were approved by senior management in the first quarter of 2019 and the Company has implemented a substantial portion of the identified actions. Along with additional initiatives expected to be implemented over the next two years, these actions are expected to drive substantial benefits in 2020 and future years. Management also anticipates incurring certain one-time expenses, which may be significant, relating to the review and implementation of the identified initiatives. 2020 Outlook In 2020, the Company expects overall net sales to decrease as compared to 2019 driven by continuing volume declines across each segment. In the Magazines, Catalogs and Logistics segment, the Company expects an organic net sales decline driven by the ongoing shift in advertiser spend from print to electronic media and declines in circulation and page counts. For the Book segment, the Company expects volume declines in college and religious books and consistent volumes in K-12 education books and trade books, along with modest growth in services revenues. Office Products net sales are expected to decrease in 2020 as compared to 2019 as a result of volume declines driven by continuing secular decline. While cost inflation driven primarily by tight labor market conditions will continue to pressure operating margins during 2020, the Company also expects to realize significant cost savings from restructuring initiatives, ongoing productivity efforts and some remaining integration related to the logistics acquisitions. The Company has initiated several restructuring actions during 2019 and early in 2020 to further reduce the Company's overall cost structure. These restructuring actions included the closure of five manufacturing facilities in the Magazine, Catalog and Logistics segment, three in the Office Products segment and one each in the Book andMexico segments. These cost reduction actions are expected to have significant positive impacts on operating earnings in 2020 and in future years. In addition, the Company expects to realize other cost reduction opportunities through its ongoing focus on productivity improvement, including initiatives identified as part of management's ongoing comprehensive review of operations. The Company's cost reduction initiatives may result in significant additional restructuring charges. These restructuring actions will be funded by cash generated from operations and cash on hand or, if necessary, by utilizing the Company's credit facilities. Cash flows from operations in 2020 are expected to benefit from the impact of working capital reductions driven by lower volume, but will be negatively impacted by higher expenditures related to restructuring actions. The Company expects capital expenditures to be in the range of$50 million to$60 million in 2020. Capital expenditures are expected to be primarily directed towards increased automation and productivity, equipment to enable cost reduction through facility closures, and growth opportunities driven mainly by specific customer needs. The Company's net pension liability was$162 million as ofDecember 31, 2019 , as reported on the Company's consolidated balance sheet and further described in Note 15, Retirement Plans, to the consolidated financial statements. Governmental regulations for measuring pension plan funded status differ from those required under accounting principles generally accepted inthe United States of America ("GAAP") for financial statement preparation. Based on the plans' regulatory funded status, there are no required contributions for the Company'sU.S. Qualified Plan in 2020. The Company does expect to make approximately$6 million of pension contributions in 2020, primarily for its Non-Qualified plan. 29
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SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ESTIMATES
Basis of Presentation The preparation of consolidated financial statements, in conformity with GAAP, requires the extensive use of management's estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates. Estimates are used when accounting for items and matters including, but not limited to, allowance for uncollectible accounts receivable, inventory obsolescence, asset valuations and useful lives, taxes, restructuring and other provisions and contingencies. The Company's most critical accounting policies are those that are most important to the portrayal of its financial condition and results of operations, and that require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The Company has identified the following as its most critical accounting policies and judgments. Although management believes that its estimates and assumptions are reasonable, they are based upon information available when they are made, and therefore, actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition As previously mentioned, the Company adopted ASC 606 onJanuary 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. The reported results for 2019 and 2018 reflect the application of ASC 606 guidance while the reported results for years prior to 2018 were prepared and continue to be reported under the previous guidance. The Company recognizes revenue at a point in time for substantially all customized products. The point in time when revenue is recognized is when the performance obligation has been completed and the customer obtains control of the products, which is generally upon shipment to the customer (dependent upon specific shipping terms). Under agreements with certain customers, custom products may be stored by the Company for future delivery. Based upon contractual terms, the Company is typically able to recognize revenue once the performance obligation is satisfied and the customer obtains control of the completed product, usually when it completes production (depending on the specific facts and circumstances). In these situations, the Company may also receive a logistics or warehouse management fee for the services it provides, which the Company recognizes over time as the services are provided. With certain customer contracts, the Company is permitted to complete a pre-defined amount of custom products and hold such inventory until the customer requests shipment (which generally is required to be delivered in the same year as production). For these items, which include consigned inventory, the Company has the contractual right to receive payment once the production is completed, regardless of the ultimate delivery date. Based upon contractual terms, the Company recognizes revenue once the performance obligation has been satisfied and the customer obtains control of the completed products, usually when production is completed. In very limited situations, the Company is permitted to produce and hold in inventory a pre-defined amount of custom products as safety stock. Similar to completed production held in inventory, for these items, the Company has the contractual right to receive payment for the pre-defined amount once the production is completed, regardless of the ultimate delivery date. Based upon our evaluation of the contractual terms, the Company is able to recognize revenue once the performance obligation has been satisfied and the customer obtains control of the completed product, usually when production is completed. Revenue from the Company's print related services (including list processing, mail sortation services and supply chain management) is recognized as services are completed over time. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing services, which is based on transaction prices set forth in contracts with customers and an estimate of variable consideration, as applicable. Variable consideration resulting from volume rebates, fixed rebates, penalties or credits for paper consumption, and sales discounts that are offered within contracts between the Company and its customers is recognized in the period the related revenue is recognized. Estimates of variable consideration are based on stated contract terms and an analysis of historical experience. The amount of variable consideration is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. 30 -------------------------------------------------------------------------------- A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. For contracts with multiple performance obligations, such as co-mail and catalog production, the transaction price allocated to each performance obligation is based on the price stated in the customer contract, which represents the Company's best estimate of the standalone selling price of each distinct good or service in the contract. Billings for shipping and handling costs are recorded gross. The Company made an accounting policy election under ASC 606 to account for shipping and handling after the customer obtains control of the good as fulfillment activities rather than as a separate service to the customer. As a result, the Company accrues the costs of the shipping and handling if revenue is recognized for the related good before the fulfillment activities occur. Many of the Company's operations process materials, primarily paper, that may be supplied directly by customers or may be purchased by the Company and sold to customers as part of the end product. No revenue is recognized for customer-supplied paper, but revenues for Company-supplied paper are recognized on a gross basis. As a result, the Company's reported sales and margins may be impacted by the mix of customer-supplied paper and Company-supplied paper.
The Company records taxes collected from customers and remitted to governmental authorities on a net basis.
Contracts do not contain a significant financing component as payment terms on invoiced amounts are typically between 30 to 120 days, based on the Company's credit assessment of individual customers, as well as industry expectations. The timing of revenue recognition, billings and cash collections results in accounts receivable and unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the consolidated balance sheet. Revenue recognition generally coincides with the Company's contractual right to consideration and the issuance of invoices to customers. Depending on the nature of the performance obligation and arrangements with customers, the timing of the issuance of invoices may result in contract assets or contract liabilities. Contract assets related to unbilled receivables are recognized for satisfied performance obligations for which the Company cannot yet issue an invoice. Contract liabilities result from advances or deposits from customers on performance obligations not yet satisfied. Because the majority of the Company's products are customized, product returns are not significant; however, the Company accrues for the estimated amount of customer returns at the time of sale.
Refer to Note 4, Revenue Recognition, to the consolidated financial statements for information related to new standard.
The Company's methodology for allocating the purchase price of acquisitions is based on established valuation techniques that reflect the consideration of a number of factors, including valuations performed by third-party appraisers when appropriate.Goodwill is measured as the excess of the cost of an acquired entity over the fair value assigned to identifiable assets acquired and liabilities assumed. Based on its current organization structure as ofDecember 31, 2019 , the Company has identified seven reporting units for which cash flows are determinable and to which goodwill may be allocated.Goodwill is assigned to a specific reporting unit, depending on the nature of the underlying acquisition. The Company performs its goodwill impairment tests annually as ofOctober 31 , or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company also performs an interim review for indicators of impairment each quarter to assess whether an interim impairment review is required for any reporting unit. As part of its interim reviews, management analyzes potential changes in the value of individual reporting units based on each reporting unit's operating results for the period compared to expected results as of the prior year's annual impairment test. In addition, management considers how other key assumptions, including discount rates and expected long-term growth rates, used in the last annual impairment test could be impacted by changes in market conditions and economic events. 31 -------------------------------------------------------------------------------- The Company determines the fair value of its reporting units using both the income approach and the market approach. The determination of the fair value using the income approach requires management to make significant estimates and assumptions related to projected operating results (including forecasted revenue and operating income), anticipated future cash flows, and discount rates. The determination of the fair value using the market approach requires management to make significant assumptions related to the multiples of earnings before interest, income taxes, depreciation and amortization ("EBITDA") used in the calculation. Additionally, the market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping. The Company weighs both the income and market approach equally to estimate the concluded fair value of each reporting unit. The determination of fair value and the allocation of that value to individual assets and liabilities requires the Company to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which the Company competes; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, restructuring charges and capital expenditures. As part of its impairment test for its reporting units, the Company engages a third-party valuation firm to assist in the Company's determination of certain assumptions used to estimate fair values.
Interim Impairment Tests Performed in the Third Quarter of 2019
The Company's stock price has experienced a significant, sustained decline - especially since the Merger Agreement termination was announced in lateJuly 2019 . Shortly after the Merger Agreement termination, the Company announced that it was indefinitely suspending its dividend and lowered its guidance for the year. As a result, the Company determined it necessary to perform goodwill impairment reviews on the Book, logistics and Office Products reporting units (the only reporting units that had goodwill) as ofAugust 31, 2019 . The Company performed a one-step method of for determining goodwill impairment for the three reporting units. As a result of the one-step impairment test for Book, logistics and Office Products, the Company did not recognize any goodwill impairment charges as ofAugust 31, 2019 as the estimated fair values of the reporting units exceeded their respective carrying values. Book, logistics and Office Products passed with fair values that exceeded their carrying values by 28.2%, 55.9% and 16.8%, respectively.
Impairment Tests Performed in the Fourth Quarter of 2019
The Company performed its annual impairment test as ofOctober 31, 2019 . The goodwill balances as ofOctober 31, 2019 for the three reporting units that had goodwill were as follows: logistics ($21 million ), Book ($51 million ) and Office Products ($31 million ). For the logistics, Book and Office Products reporting units, management assessed goodwill impairment risk by first performing a qualitative review of entity specific, industry, market and general economic factors for each reporting unit. As a result of the qualitative assessment for logistics and Office Products and considering that a goodwill impairment analysis was performed as ofAugust 31, 2019 with no impairment recorded, the Company concluded it was more likely than not the fair values of the reporting units are greater than their carrying values, and therefore, the Company did not recognize any goodwill impairment charges. For Book, the Company was not able to conclude that it is more likely than not that the fair values of our reporting units are greater than their carrying values, and therefore, a one-step method for determining goodwill impairment was applied as ofOctober 31, 2019 . The Company compared the estimated fair value of a reporting unit with its carrying amount, including goodwill. As a result of the 2019 annual impairment test for Book, the Company fully impaired Book's goodwill and recorded a$51 million goodwill impairment charge as the carrying value of the reporting unit did not exceed its estimated fair value. This is primarily due to the negative revenue trends experienced in the fourth quarter of 2019 and lower revenue forecasts in future years.
Goodwill Impairment Assumptions
Although the Company believes its estimates of fair value are reasonable, actual
financial results could differ from those estimates due to the inherent
uncertainty involved in making such estimates. Management prepares estimates and
assumptions related to forecasts of future revenues, forecasts of future
operating income, and the selection of the discount rates and EBITDA
multiples. Changes in assumptions concerning future financial results or other
underlying assumptions could have a significant impact on either the fair value
of the reporting units, the amount of the goodwill impairment charge, or both.
Future declines in the overall market value of the Company's debt securities and
changes in other economic conditions may also result in a conclusion that the
fair value of one or more reporting units has declined below its carrying value.
32
--------------------------------------------------------------------------------Other Long-Lived Assets The Company evaluates the recoverability of other long-lived assets, including property, plant and equipment, certain identifiable intangible assets, and right-of-use lease assets, whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. The Company performs impairment tests of indefinite-lived intangible assets on an annual basis or more frequently in certain circumstances. Factors that could trigger an impairment review include significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the assets or the strategy for the overall business, a significant decrease in the market value of the assets or significant negative industry or economic trends. When the Company determines that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the indicators, the assets are assessed for impairment based on the estimated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the carrying value of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recorded for the excess of the asset's carrying value over its fair value.
Given the continued decline in demand in the magazines and catalogs reporting unit, management determined that a further review of the reporting unit's intangible assets and property, plant and equipment for recoverability was appropriate during the second, third and fourth quarters in 2019:
• As a result of the faster pace of decline in demand, negative revenue
trends and lower expectations of future revenue to be derived from certain
customer relationships, management determined that a certain definite-lived
customer relationship intangible asset recorded in the magazines and
catalogs reporting unit was not recoverable as a result of the
recoverability test performed as of June 30, 2019 . This resulted in the
Company recording a
ended
determined using Level 3 inputs and estimated based on cash flow analyses,
which included management's assumptions related to future revenues and
profitability.
• With respect to property, plant and equipment and right-of-use assets for
operating leases, the Company performed a Step 1 recoverability test in
accordance with Accounting Standards Codification ("ASC") 360, Property,
Plant and Equipment. The recoverability test compares the estimated future
undiscounted cash flows expected to result from the use of the asset group
and its eventual disposition to the carrying value of the asset group; if
the carrying value of the asset group exceeds its estimated future
undiscounted cash flows, an impairment loss is recorded for the excess of
the asset group's carrying value over its fair value. Based upon
management's updated projection of cash flows for this asset group,
management determined that the estimated future undiscounted cash flows
were in excess of the asset group's carrying value, resulting in no
impairment loss as a result of these tests in 2019.
In addition to the annual goodwill impairment test performed for Book as of
October 31, 2019 , the Company reviewed the reporting unit's intangible assets
and property, plant and equipment for recoverability in the fourth quarter of
2019. There were no impairment charges recorded as a result of the
recoverability tests.
The Company recognized impairment charges of $18 million related to intangible
assets and $10 million related to machinery and equipment for the Company during
the year ended December 31, 2019 . The impairment recognized on machinery and
equipment was primarily associated with facility closings in the Magazines,
Catalogs and Logistics and Book segments.
The Company will continue to perform interim reviews of goodwill for indicators
of impairment each quarter to assess whether an interim impairment test is
required for its goodwill balances or if recoverability tests are required for
long-lived assets, including property, plant and equipment, and certain
identifiable intangible assets, whenever events or changes in circumstances
indicate that the carrying value of an asset or asset group may not be
recoverable. Such reviews could result in future impairment charges, depending
on the facts and circumstances in effect at the time of those reviews.
Pension
The Company is the sole sponsor of certain defined benefit plans, which have
been reflected in the consolidated balance sheets at December 31, 2019 and
2018. The Company records annual income and expense amounts relating to its
pension plans based on calculations that include various actuarial assumptions,
including discount rates, mortality, assumed rates of return, compensation
increases, and turnover rates. The Company reviews its actuarial assumptions on
an annual basis and makes modifications to the assumptions based on current
rates and trends when it is deemed appropriate to do so. The effects of
modifications on the value of
33
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plan obligations and assets is recognized immediately within other comprehensive
income (loss) and amortized into investment and other (income)-net over future
periods. The Company believes that the assumptions utilized in recording its
obligations under its plans are reasonable based on its experience, market
conditions and input from its actuaries and investment advisors.
In the first quarter of 2019, the Company completed a partial settlement of its
retirement benefit obligations by purchasing a group annuity contract for
certain retirees and beneficiaries from a third-party insurance company. As a
result, the Company's pension assets and liabilities were remeasured as of the
settlement date. The Company recorded a non-cash settlement charge of $135
million in settlement of retirement benefit obligations in the consolidated
statement of operations in the first quarter of 2019. There were additional
immaterial lump-sum settlements (unrelated to the transaction noted above)
during the year ended December 31, 2019 that resulted in non-cash settlement
charges of $2 million .
The weighted-average discount rates used to determine the net benefit
obligations for all pension benefit plans were 3.3% and 4.4% at
A one-percentage point change in the discount rates atDecember 31, 2019 would have the following effects on the accumulated benefit obligation and projected benefit obligation for all pension benefit plans: 1% Increase 1% Decrease (in millions) Non- Non- Qualified Qualified & & Qualified International Total Qualified International Total
Accumulated benefit obligation$ (249 ) $ (9 )$ (258 ) $ 306 $ 11$ 317 Projected benefit obligation (249 ) (9 ) (258 ) 306 11 317 The Company'sU.S. pension plans are frozen and the Company has previously transitioned to a risk management approach for itsU.S. pension plan assets. The overall investment objective of this approach is to further reduce the risk of significant decreases in the plan's funded status by allocating a larger portion of the plan's assets to investments expected to hedge the impact of interest rate risks on the plan's obligation. Over time, the target asset allocation percentage for the pension plan is expected to decrease for equity and other "return seeking" investments and increase for fixed income and other "hedging" investments. The assumed long-term rate of return for plan assets, which is determined annually, is likely to decrease as the asset allocation shifts over time. The impact of a change in interest rates on the accumulated benefit obligation and projected benefit obligation would be partially offset by the corresponding impact on the fair value of pension assets of hedging investments. The impact of a change in interest rates would increase or decrease the fair value of pension assets of hedging investments. The expected long-term rate of return for plan assets is based upon many factors including expected asset allocations, historical asset returns, current and expected future market conditions and risk. In addition, the Company considered the impact of the current interest rate environment on the expected long-term rate of return for certain asset classes, particularly fixed income. The target asset allocation percentage for theU.S. Qualified Plan was approximately 40.0% for return seeking investments and approximately 60.0% for hedging investments. The expected long-term rate of return on plan assets assumption used to calculate net pension plan expense in 2019 was 6.50% for the Company'sU.S. Qualified pension plan. The expected long-term rate of return on plan assets assumption that will be used to calculate net pension plan expense in 2020 is 6.00% for the Company'sU.S. Qualified pension plan. A 0.25% change in the expected long-term rate of return on all plan assets atDecember 31, 2019 would have the following effects on 2019 and 2020 pension plan (income)/expense in the Company's pension benefit plans: 0.25% Increase 0.25% Decrease in millions 2019 $ (5 ) $ 5 2020 (5 ) 5
Accounting for Income Taxes
The Company has recorded deferred tax assets related to future deductible items,
including domestic and foreign tax loss and credit carryforwards. The Company
evaluates these deferred tax assets by tax jurisdiction. The utilization of
these tax assets is limited by the amount of taxable income expected to be
generated within the allowable carryforward period and other factors.
Accordingly, the Company has recorded valuation allowances to reduce certain of
these deferred tax assets when management has concluded that,
34
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based on the weight of available evidence, it is more likely than not that the
deferred tax assets will not be fully realized. A significant piece of objective
negative evidence is the cumulative loss incurred over the three-year period
ended December 31, 2019 , which limits the ability to consider other subjective
evidence, such as our projections for future operating results. As a result, the
Company appropriately scheduled out the future reversals of its deferred tax
assets and liabilities. As of December 31, 2019 and 2018, valuation allowances
of $77 million and $11 million , respectively, were recorded in the Company's
consolidated balance sheets. If actual results differ from these estimates, or
the estimates are adjusted in future periods, adjustments to the valuation
allowances might need to be recorded.
Significant judgment is required in determining the provision for income taxes
and related accruals, deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. In the ordinary course of
business, there are transactions and calculations where the ultimate tax outcome
is uncertain. Additionally, the Company's tax returns are subject to audit by
various U.S. and foreign tax authorities. The Company recognizes a tax position
in its financial statements when it is more likely than not that the position
would be sustained upon examination by tax authorities. This recognized tax
position is then measured at the largest amount of benefit that is greater than
fifty percent likely than not of being realized upon ultimate settlement.
Although management believes that its estimates are reasonable, the final
outcome of uncertain tax positions may be materially different from that which
is reflected in the Company's consolidated financial statements. As of December
31, 2019 , a de minimis amount of unrecognized tax benefits were recognized in
the consolidated balance sheets. The Company classifies interest expense and any
related penalties related to income tax uncertainties as a component of income
tax expense.
Refer to Note 16, Income Taxes, for further discussion.
Commitments and Contingencies The Company is subject to lawsuits, investigations and other claims related to environmental, employment, commercial and other matters, as well as preference claims related to amounts received from customers and others prior to their seeking bankruptcy protection. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the related liability is estimable, the Company accrues a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the related potential liability and may revise its estimates. With respect to claims made under the Company's third-party insurance for workers' compensation, automobile and general liability, the Company is responsible for the payment of claims below and above insured limits, and consulting actuaries are utilized to assist the Company in estimating the obligation associated with any such incurred losses, which are recorded in accrued and other non-current liabilities. Historical loss development factors for both the Company and the industry are utilized to project the future development of such incurred losses, and these amounts are adjusted based upon actual claims experience and settlements. If actual experience of claims development is significantly different from these estimates, an adjustment in future periods may be required. Expected recoveries of such losses are recorded in other current and other non-current assets. Accounts Receivable The Company maintains an allowance for doubtful accounts receivable, which is reviewed for estimated losses resulting from the inability of its customers to make required payments for products and services. Specific customer provisions are made when a review of significant outstanding amounts, utilizing information about customer creditworthiness and current economic trends, indicates that collection is doubtful. In addition, provisions are made at differing rates, based upon the age of the receivable and the Company's collection experience. The allowance for doubtful accounts receivable was$12 million and$14 million atDecember 31, 2019 and 2018, respectively. The Company's estimates of the recoverability of accounts receivable could change, and additional changes to the allowance could be necessary in the future if any major customer's creditworthiness deteriorates or actual defaults are higher than the Company's historical experience. FINANCIAL REVIEW In the financial review that follows, the Company discusses its consolidated statements of operations, balance sheets, cash flows and certain other information. This discussion should be read in conjunction with the Company's consolidated financial statements and the related notes that begin on page F-1. 35
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Results of Operations for the Year Ended
The following table shows the results of operations for the years ended
2019 2018 $ Change % Change
(in millions, except percentages)
Net sales $ 3,326 $ 3,826 $ (500 ) (13.1 %)
Cost of sales 2,888 3,283 (395 ) (12.0 %)
Cost of sales as a % of net sales 86.8 % 85.8 %
Selling, general and administrative expenses
(exclusive of depreciation
and amortization) 327 328 (1 ) (0.3 %)
Selling, general and administrative expenses
as a % of net sales 9.8 % 8.6 %
Restructuring, impairment and other
charges-net 148 35 113 322.9 %
Depreciation and amortization 120 138 (18 ) (13.0 %)
(Loss) income from operations $ (157 ) $ 42 $ (199 ) (473.8 %)
Consolidated Results
Net sales for the year ended December 31, 2019 were $3,326 million , a decrease
of $500 million or 13.1% compared to the year ended December 31, 2018 . Net sales
were impacted by:
• Lower volume, the dispositions of the Company's European printing business
and retail offset printing facilities in 2018 and a
pass-through paper sales; and
• The acquisition of Print Logistics in 2018.
On a pro forma basis, the Company's net sales for the year ended December 31,
2019 decreased by approximately $585 million or 14.9% compared to the year ended
December 31, 2018 (refer to Note 3, Business Combinations and Disposition, to
the consolidated financial statements). The decrease was primarily due to lower
volume and the Company's disposition of its European printing business and
retail offset printing facilities in 2018.
Total cost of sales decreased $395 million , or 12.0%, for the year ended
December 31, 2019 compared to the year ended December 31, 2018 , primarily due to
the dispositions of the Company's European printing business and retail offset
printing facilities in 2018, lower volume, a $26 million gain on the sale of
land and a building associated with a plant closure in the Magazines, Catalogs
and Logistics segment in the fourth quarter of 2019, and a gain on the sale of
the Company's commingle operations in 2019, partially offset by costs incurred
by the acquisition of Print Logistics.
Selling, general and administrative expenses decreased by $1 million to $327
million for the years ended December 31, 2019 compared to the year ended
December 31, 2018 . This was driven by the disposition of the Company's European
printing business, partially offset by costs associated with the Merger
Agreement.
For the year ended
•
Refer to Note 10, Restructuring, Impairment and Other Charges, for more
information;
• Employee-related charges of
of whom 357 were terminated as of or prior to
related to five facility closures in the Magazines, Catalogs and Logistics
segment and one facility closure in the Book segment;
• Other restructuring charges of
costs associated with new revenue opportunities and cost savings initiatives
implemented in 2019, and pension withdrawal obligations related to facility
closures;
• $17 million for the impairment of certain definite-lived customerrelationships intangible assets in the Magazines, Catalogs and Logistics
segment; and
•
and equipment associated with facility closings in the Magazines, Catalogs
and Logistics and Book segments.
36
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For the year ended
• Employee-related charges of
of whom 282 were terminated as of or prior to
related to two facility closures in the Magazines, Catalogs and Logistics
segment, one facility closure in the Office Products segment and the
reorganization of certain business units and corporate functions.
• Other restructuring charges of
to facility costs, a loss related to the Company's disposition of its
retail offset printing facilities and pension withdrawal obligations
related to facility closures;
•
and equipment associated with facility closings in the Magazines, Catalogs
and Logistics segment; and
•
tradenames intangible assets in the Office Products segment.
• The charges above were partially offset by a reduction of
goodwill impairment charges as a result of a $1 million adjustment of
previously recorded goodwill associated with the 2017 acquisitions.
Depreciation and amortization decreased $18 million to $120 million for the year
ended December 31, 2019 compared to the year ended December 31, 2018 due to due
to decreased capital spending in recent years compared to historical levels and
the disposition of the Company's European printing business, partially offset by
the acquisition of Print Logistics.
2019 2018 $ Change % Change
(in millions, except percentages)
Interest expense-net $ 76 $ 80 $ (4 ) (5.0 %)
Settlement of retirement benefit obligations 137 - 137 100.0 %
Termination fee from Quad (45 ) - (45 ) 100.0 %
Investment and other (income)-net (37 ) (48 ) 11 (22.9 %)
Refer to Note 15, Retirement Plans, for information on the non-cash settlement
charge related to retirement benefit obligations. Refer to Note 1, Overview and
Basis of Presentation, for information on the termination fee received from
Quad. Investment and other (income)-net primarily relates to the Company's
pension benefit plans in both years.
2019 2018 $ Change
(in millions, except percentages)
Net (loss) income before income taxes
(298 ) Income tax expense 7 33 (26 ) Effective income tax rate (2.3 %) 319.4 %
The effective income tax rate was (2.3%) for the year ended
The effective income tax rate was 319.4% for the year endedDecember 31, 2018 and reflects a$25 million non-cash tax provision related to the disposition of the Company's European printing business. Refer to the Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Company's annual report on Form 10-K for the year endedDecember 31, 2018 , as filed with theSEC onFebruary 19, 2019 , for a discussion of results of operations for the year ended 2018 as compared to the year ended 2017. Information by Segment The following tables summarize net sales, income (loss) from operations and certain items impacting comparability within each of the reportable segments and Corporate. The descriptions of the reporting units generally reflect the primary products provided by each reporting unit. 37
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Magazines, Catalogs and Logistics
2019 2018 Change
(in millions, except percentages)
Net sales $ 1,559 $ 1,767 $ (208 )
(Loss) from operations (114 ) (31 ) (83 )
Operating margin (7.3 %) (1.8 %) (550) bps
Gain on the sale of fixed assets (26 ) - (26 )
Restructuring, impairment and other
charges-net 67 20 47
Net sales for the Magazines, Catalogs and Logistics segment for the year ended
December 31, 2019 were $1,559 million , a decrease of $208 million , or 11.7%,
compared to 2018. Net sales decreased primarily due the unprecedented drop in
long-run magazine and catalog volumes during 2019, with the faster pace of
decline in demand primarily due to the accelerated impact of digital disruption
of demand for printed materials. In addition, the disposition of the Company's
retail offset printing facilities, lower logistics volume, and a $35 million
decrease in pass-through paper sales contributed to the decrease, all of which
was partially offset by the acquisition of Print Logistics.
The increase in Magazines, Catalogs and Logistics segment loss from operations
and change in operating margins was primarily due to higher restructuring,
impairment and other charges and lower volume, partially offset by a $26 million
gain on the sale of land and a building associated with a plant closure in the
fourth quarter of 2019.
Book
2019 2018 Change
(in millions, except percentages)
Net sales $ 1,011 $ 1,055 $ (44 )
(Loss) income from operations (36 ) 58 (94 )
Operating margin (3.6 %) 5.5 % (910 bps)
Restructuring, impairment and other
charges-net 66 6 60
Net sales for the Book segment for the year ended December 31, 2019 were $1,011
million , a decrease of $44 million , or 4.2%, compared to 2018, largely as a
result of lower volume in digitally-printed and educational books, partially
offset by higher volume in fulfillment and procurement services and a $2 million
increase in paper sales.
The decrease in the operating income and margins was driven by higher restructuring, impairment, and other charges-net and higher labor costs in manufacturing and fulfillment operations.
Office Products
2019 2018 Change
(in millions, except percentages)
Net sales $ 517 $ 562 $ (45 )
Income from operations 42 40 2
Operating margin 8.1 % 7.1 % 100 bps
Restructuring, impairment and other
charges-net 4 6 (2 )
Purchase accounting adjustments - 1 (1 )
Net sales for the Office Products segment for the year ended December 31, 2019
were $517 million , a decrease of $45 million , or 8.1%, compared to 2018, largely
as a result of lower volume in filing, envelopes and notetaking products.
The increase in Office Products segment income from operations and operating
margin was primarily due to synergies realized from the integration of Quality
Park and cost reductions, both of which increased the operating margin,
partially offset by lower volume and higher labor costs.
38
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Mexico 2019 2018 Change (in millions, except percentages) Net sales$ 91 $ 97 $ (6 ) Income from operations 14 13 1 Operating margin 15.4 % 13.4 % 200 bps Net sales forMexico for the year endedDecember 31, 2019 were$91 million , a decrease of$6 million , or 5.7% compared to 2018. The decrease was primarily due to lower volume. The increase in income from operations and operating margin was due to cost control initiatives. Other 2019 2018 Change (in millions, except percentages) Net sales$ 149 $ 347 $ (198 ) Income from operations 7 13 (6 ) Operating margin 4.7 % 3.7 % 100 bps Restructuring, impairment and other charges-net - 1 (1 ) Net sales for the Other grouping for the year endedDecember 31, 2019 were$149 million , a decrease of$198 million , or 57.0%, compared to 2018, primarily due to the disposition of the Company's European printing business, lower directories volume and a$10 million decrease in pass-through paper sales, partially offset by higher sales in outsourced services.
The decrease in income from operations was primarily due to lower volume. The mix of volume helped to improve the operating margin compared to the prior year.
Corporate
The following table summarizes unallocated operating expenses and certain items impacting comparability within the activities presented as Corporate:
2019 2018 Change
(in millions, except percentages)
Total operating expenses $ 70 $ 51 $ 19
Significant components of total
operating
expenses:
Restructuring, impairment and other charges-net 11 2 9 Share-based compensation expenses 7 12 (5 ) Expenses related to acquisitions, the Merger Agreement and dispositions 23 10 13 Refer to the Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Company's annual report on Form 10-K for the year endedDecember 31, 2018 , as filed with theSEC onFebruary 19, 2019 , for a discussion of information by segment for the year ended 2018 as compared to the year ended 2017. Non-GAAP Measures The Company believes that certain non-GAAP measures, such as Non-GAAP adjusted EBITDA, provide useful information about the Company's operating results and enhance the overall ability to assess the Company's financial performance. The Company uses these measures, together with other measures of performance under GAAP, to compare the relative performance of operations in planning, budgeting and reviewing the performance of its business. Non-GAAP adjusted EBITDA allows investors to make a more meaningful comparison between the Company's core business operating results over different periods of time. The Company believes 39 -------------------------------------------------------------------------------- that Non-GAAP adjusted EBITDA, when viewed with the Company's results under GAAP and the accompanying reconciliations, provides useful information about the Company's business without regard to potential distortions. By eliminating potential differences in results of operations between periods caused by factors such as depreciation and amortization methods and restructuring, impairment and other charges, the Company believes that Non-GAAP adjusted EBITDA can provide a useful additional basis for comparing the current performance of the underlying operations being evaluated. Non-GAAP adjusted EBITDA is not presented in accordance with GAAP and has important limitations as an analytical tool. Readers should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP. In addition, these measures are defined differently by different companies in our industry and, accordingly, such measures may not be comparable to similarly-titled measures of other companies. Non-GAAP adjusted EBITDA excludes restructuring, impairment and other charges-net, gain on the sale of fixed assets associated with a plant closure, the termination fee from Quad, settlement of retirement benefit obligations, expenses related to acquisitions, the Merger Agreement and dispositions, purchase accounting adjustments, separation-related expenses, and loss on debt extinguishment.
A reconciliation of GAAP net income to non-GAAP adjusted EBITDA for the years
ended
2019 2018 2017
Net (loss) $ (295 ) $ (23 ) $ (57 ) Restructuring, impairment and other charges-
net 148 35 129 Gain on the sale of fixed assets (26 ) - - Termination fee from Quad (45 ) - -
Settlement of retirement benefit obligations 137 - - Expenses related to acquisitions, the
Merger Agreement and dispositions 23 10 5 Purchase accounting adjustments - 3 (1 ) Separation-related expenses - - 4 Loss on debt extinguishment - - 3 Depreciation and amortization 120 138 160 Interest expense-net 76 80 72 Income tax expense (benefit) 7 33 13 Non-GAAP adjusted EBITDA$ 145 $ 276 $ 328 • Refer to Note 10, Restructuring, Impairment and Other Charges for
information on restructuring, impairment and other charges for the years
ended December 31, 2019 , 2018 and 2017.
• Termination fee from Quad: Refer to Note 1, Overview and Basis of
Presentation, for more information on the fee received.
• Gain on the sale of fixed assets: During the fourth quarter of 2019, the
Company sold land and a building associated with a plant closure. The
million gain was recorded in cost of sales in the consolidated statement of
operations.
• Settlement of retirement benefit obligations: Refer to Note 15, Retirement
Plans, for more information on the settlement charges.
• Expenses related to acquisitions, the Merger Agreement and dispositions: The
year ended
related to costs associated with the Merger Agreement. The year ended
accounting and other expenses associated with completed and contemplated
acquisitions, costs associated with the Merger Agreement and the disposition
of the Company's European printing business. The year ended
2017 included charges of
expenses associated with completed and contemplated acquisitions.
• Purchase accounting adjustments: The year ended
charges of
adjustments and changes to purchase price allocations related to prior
acquisitions. The year ended
of
a gain on acquisition.
• Separation-related expenses: The year ended
charge of
a standalone company.
40
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• Loss on debt extinguishment: The year ended
loss of
• Income tax expense: The year ended
expense of
Company's deferred tax assets. The year ended
deferred tax asset associated with the disposition of the Company's European
printing business.
LIQUIDITY AND CAPITAL RESOURCES
The following sections describe the Company's cash flows for the years ended
2019 2018
Net cash (used in) provided by operating
activities$ (4 ) $ 162
Net cash (used in) investing activities (34 ) (55 ) Net cash provided by (used in) financing
activities 119 (116 )
Cash flows from Operating Activities
Operating cash inflows are largely attributable to sales of the Company's products. Operating cash outflows are largely attributable to recurring expenditures for raw materials, labor, rent, interest, taxes and other operating activities.
Net cash used in operating activities was$4 million for the year endedDecember 31, 2019 compared to net cash provided by operating activities of$162 million for the same period in 2018. The decrease in net cash provided by operating activities is primarily due to the timing of payments to suppliers, and lower operating earnings, partially offset by working capital reductions driven by lower volume, improvements in the timing of customer payments received and the net impact of the Quad termination fee less payments for related expenses.
Cash flows from Investing Activities
Net cash used in investing activities for the year endedDecember 31, 2019 was$34 million compared to$55 million for the same period in 2018. Significant changes are as follows:
• Capital expenditures increased by
2018, primarily due to increased spend on machinery and equipment in order
to increase automation and productivity in the Book and Magazines, Catalogs
and Logistics segments:
• Cash paid for acquisitions of businesses, net of cash acquired, was impacted
by the acquisition of Print Logistics in 2018 and purchase price adjustments
resulting from finalization of working capital calculations in each period;
• Proceeds of $6 million for the year ended December 31, 2019 for the
disposition of the Company's commingle operations;
• Net proceeds of
due to the sale of land and a building associated with a plant closure in
the Magazines, Catalogs and Logistics segment, compared to net proceeds from
the sales and purchase of investments and other assets of
year ended
• Proceeds of
disposition of the Company's European printing business.
Cash flows from Financing Activities
Net cash provided by financing activities for the year endedDecember 31, 2019 was$119 million compared to cash used in financing activities of$6 million for the same period in 2018. Significant changes are as follows:
• The Company paid down
during the year ended
year ended
• The Company received net proceeds from credit facility borrowings of
million for the year ended
million for the year ended December 31, 2018 ;
41
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• The Company paid
ended
•
to the year ended December 31, 2018 .
Refer to the Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations, in the Company's annual report on Form 10-K for the
year ended December 31, 2018 , as filed with the SEC on February 19, 2019 , for a
discussion of cash flow (from operating, investing and financing activities) for
the year ended 2018 as compared to the year ended 2017.
Dividends
Cash dividends declared and paid to stockholders during the year ended
In light of lower expectations for earnings and cash flows, onJuly 18, 2019 the Board of Directors suspended dividend payments in order to allocate greater capital to the Company's debt reduction and ongoing operational restructuring programs. The dividend paid inJune 2019 is the last dividend that will be paid for the foreseeable future. Prior to the amendment to the Credit Agreement that was effective onAugust 5, 2019 that is described below, the Company was generally allowed to declare and pay annual dividend payments of up to$50 million in the aggregate. However, theAugust 5, 2019 amendment removed the general allowance to declare and pay annual dividends of up to$50 million .
See further discussion below for information regarding the
Contractual Cash Obligations and Other Commitments and Contingencies
The following table quantifies the Company's future contractual obligations as ofDecember 31, 2019 : Payments Due In Total 2020 2021 2022 2023 2024 Thereafter (in millions) Debt (a)$ 922 $ 472 $ - $ -$ 450 $ - $ - Interest due on debt (b) 191 55 51 46 39 - - Multi-employer pension withdrawals obligations 102 8 8 8 8 8 62 Operating leases 190 53 43 33 22 15 24 Deferred compensation 7 1 - - - 1 5 Pension plan contributions (c) 12 6 6 - - - - Incentive compensation 8 8 - - - - - Outsourced services 35 24 8 3 - - - Other (d) 38 38 - - - - - Total as of December 31, 2019$ 1,505 $ 665 $ 116 $ 90 $ 519 $ 24 $ 91
(a) Excludes unamortized debt issuance costs of
related to the Company's Term Loan Facility and 8.75% Senior Notes due
the Company's Term Loan Facility. These amounts do not represent
contractual obligations with a fixed amount or maturity date. All
outstanding amounts under the Company's Term Loan Facility were classified
as current as of
noncompliance with required debt ratios contained in the Credit Agreement. Refer to Item 1, Business, for more information.
(b) Includes scheduled interest payments for the 8.75% Senior Notes and
estimates for the Term Loan Facility.
(c) Includes estimated pension plan contributions for 2020 and 2021 and does
not include the obligations for subsequent periods as the Company is
unable to reasonably estimate those amounts.
(d) Other primarily includes employee restructuring-related severance payments
(
42
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Liquidity
Cash and cash equivalents were
The Company's cash balances are held in several locations throughout the world, including amounts held outside ofthe United States . Cash and cash equivalents as ofDecember 31, 2019 included$85 million in theU.S. and$20 million in international locations. UntilSeptember 30, 2019 , the Company maintained cash pooling structures that enabled participating international locations to draw on the pools' cash resources to meet local liquidity needs. Foreign cash balances were permitted to be loaned from certain cash pools toU.S. operating entities on a temporary basis in order to reduce the Company's short-term borrowing costs or for other purposes. The pooling structure was discontinued inOctober 2019 . As ofDecember 31, 2019 , the Company had$249 million of borrowings under the Revolving Credit Facility and had no availability to further draw. Additionally, the Company had$51 million in outstanding letters of credit issued under the Revolving Credit Facility as ofDecember 31, 2019 . Debt Issuances
On
OnSeptember 30, 2016 the Company entered into a credit agreement (the "Credit Agreement") that provides for (i) a senior secured term loan B facility in an aggregate principal amount of$375 million (the "Term Loan Facility") and (ii) a senior secured revolving credit facility in an aggregate principal amount of$400 million (the "Revolving Credit Facility"). The debt issuance costs and original issue discount are being amortized over the life of the facilities using the effective interest method. The Credit Agreement is subject to a number of covenants, including, but not limited to, a minimum Interest Coverage Ratio and a Consolidated Leverage Ratio, as defined in and calculated pursuant to the Credit Agreement, that, in part, restrict the Company's ability to incur additional indebtedness, create liens, engage in mergers and consolidations, make restricted payments and dispose of certain assets. Each of these covenants is subject to important exceptions and qualifications. Credit Agreement OnDecember 20, 2018 , the Company amended the Credit Agreement to, among other things, defer certain changes to the minimum Interest Coverage Ratio and the maximum Consolidated Leverage Ratio. EffectiveAugust 5, 2019 , the Company further amended the Credit Agreement to, among other things, defer certain changes to the minimum Interest Coverage Ratio and the maximum Consolidated Leverage Ratio. The following summarizes the changes to the minimum Interest Coverage Ratio and the maximum Consolidated Leverage Ratio: Original December 20, 2018 August 5, 2019 Maximum Consolidated Leverage Ratio Current ratio 3.25 to 1.00 3.25 to 1.00 3.75 to 1.00 3.50 to 1.00 and Step-down ratio 3.00 to 1.00 3.00 to 1.00 3.25 to 1.00 June 30, 2020 Step-down as of date (quarter
and
ending on or after) March 31, 2019 March 31, 2020
Minimum Interest Coverage Ratio
Current ratio 3.25 to 1.00 3.25 to 1.00 2.50 to 1.00
2.75 to 1.00
and
Step-up ratio 3.50 to 1.00 3.50 to 1.00 3.00 to 1.00
September 30,
Step-up as of date (quarter 2020 and
ending on or after) March 31, 2019 March 31, 2020 June 30, 2021
Other terms, including the outstanding principal, maturity date and other debt
covenants remained the same under the
43
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The August 5, 2019 amendment resulted in a reduction in the Revolving Credit
Facility aggregate principal amount from $400 million to $300 million and
removed the general allowance to pay annual dividends of up to $50 million . The
August 5, 2019 amendment included other changes that generally further restrict
the Company's ability to incur additional indebtedness, create liens, engage in
mergers and consolidations, make restricted payments and dispose of certain
assets. The outstanding principal and maturity date of the Term Loan Facility
remains the same, while the maturity date of the Revolving Credit Facility
remains the same.
The consolidated financial statements have been prepared assuming the Company
will continue as a going concern. Based on final results of operations for the
year ended December 31, 2019 , the Company concluded it was not in compliance
with the Consolidated Leverage Ratio and Minimum Interest Ratio contained in the
Credit Agreement as of December 31, 2019 . The noncompliance occurred on the last
day of the fourth quarter due to the following: the Company's Consolidated
Leverage Ratio exceeded the maximum level permitted and the Company's Minimum
Interest Ratio was below the minimum level permitted. On March 2, 2020 , the
Company entered into a Waiver, Forbearance Agreement and Fourth Amendment to
Credit Agreement with lenders constituting a majority under the Credit Agreement
that governs the Company's Revolving Credit Facility and Term Loan Facility. The
Waiver, Forbearance Agreement and Fourth Amendment to Credit Agreement waives
the defaults or events of default that have occurred as a result of the
financial covenant noncompliance on December 31, 2019 and prevents the lenders
from directing the Administrative Agent to accelerate the debt or exercise other
remedies as a result of certain other potential defaults or events of default
which may occur under the Credit Agreement (the "Potential Defaults") through
the period ended May 14, 2020 (such period, the "Forbearance Period"). The
Potential Defaults include potential breaches of the Company's financial
covenants with respect to the first quarter of 2020, failure to make principal
and interest payments related to the Term Loan Facility, failure to deliver
audited financial statements for the year ended December 31, 2019 without a
going concern qualification or exception, and failure to provide notice with
respect to the Potential Defaults. The Waiver, Forbearance Agreement and Fourth
Amendment to Credit Agreement contains certain covenants and requirements, and
failure to comply with these covenants and requirements could result in the
termination of the Waiver, Forbearance Agreement and Fourth Amendment to Credit
Agreement (and the Forbearance Period) prior to its stated term. Following the
end of the Forbearance Period, the lenders may choose not to provide a full
waiver of the Potential Defaults, should any occur. The Waiver, Forbearance
Agreement and Fourth Amendment to Credit Agreement requires the Company to pay a
waiver fee of 0.30% of the Aggregate Exposure of the Consenting Lenders as of
the effective date of the Waiver, Forbearance Agreement and Fourth Amendment to
Credit Agreement. Should any of the Potential Defaults occur, unless the Company
obtains an extension or another waiver, upon the termination of the Forbearance
Period, the Company's debt under the Revolving Credit Facility and Term Loan
Facility could be in default and could be accelerated by lenders, which would
require the Company to pay all amounts outstanding and could result in a default
under, and the acceleration of, our other debt. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Going Concern
The financial statements included in this annual report on Form 10-K have been prepared assuming the Company will continue as a going concern.
The ability to continue as a going concern is dependent upon the Company
entering into an amendment to the Credit Agreement, including revised covenants,
or obtaining financing to replace the current facility, as well as continuing
profitable operations, continuing to meet its obligations, and continuing to
repay its liabilities arising from normal business operations when they become
due. The Company has evaluated its plans to alleviate this doubt, which may
include obtaining amended terms from its current lenders to allow for sufficient
flexibility in the financial covenants after giving consideration to the
Company's current operations and strategic plans, or evaluating strategic
alternatives in order to reduce the Company's indebtedness. As of the issuance
date of these consolidated financial statements, such plans cannot yet be
considered probable (as defined by ASC 205-40, "Going Concern") of
occurring. Negotiations with our lenders may require the Company to raise
additional capital and/or pursue the sale of non-core assets to reduce existing
debt. There can be no assurance that the Company will be successful in its plans
to refinance, to obtain alternative financing on acceptable terms or to sell
non-strategic assets, when required or if at all. If such plans are not
realized, the Company may be forced to limit its business activities or be
unable to continue as a going concern, which will have a material adverse effect
on our consolidated results of operations and financial condition. Management
anticipates incurring certain one-time expenses, which may be significant,
during 2020 relating to the plans it may pursue to alleviate the substantial
doubt about the Company's ability to continue as a going concern.
If we need to raise additional capital through public or private debt or equity
financings, strategic relationships, or other arrangements, this capital might
not be available to us in a timely manner, on acceptable terms, or at all. Our
failure to raise sufficient capital when needed could severely constrain or
prevent us from, among other factors, developing new or enhancing existing
services or products, acquiring other services or technologies, or funding
significant capital expenditures and may have a material adverse
44
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effect on our business, financial position, results of operations, and cash
flows, as well as impair our ability to service our debt obligations. If
additional funds were raised through the issuance of equity or convertible debt
securities, the percentage of stock owned by the then-current stockholders could
be reduced. Furthermore, such equity or any debt securities that we issue might
have rights, preferences, or privileges senior to holders of our common stock.
In addition, trends in the securities and credit markets may restrict our
ability to raise any such additional funds, at least in the near term.
As a result of the factors noted above, we believe there is substantial doubt
about the Company's ability to continue as a going concern. The consolidated
financial statements included in this annual report on Form 10-K do not include
any adjustments related to the recoverability and classification of liabilities
that might be necessary should the Company be unable to continue as a going
concern. The audit opinion on our consolidated financial statements includes an
emphasis of matter paragraph related to the substantial doubt surrounding the
Company's ability to continue as a going concern.
Other Information
On July 26, 2019 , S&P Global Ratings ("S&P") downgraded the Company's credit
ratings as noted below and lowered the issuer credit rating from B to CCC+. On
August 14, 2019 , Moody's Investors Service ("Moody's) downgraded the Company's
credit ratings as noted below and changed the outlook from stable to negative.
Moody's S&P
Prior Rating New Rating Prior Rating New Rating
Corporate family B2 B3 not applicable not applicable
Revolving Credit Facility Ba2 Ba3 BB- B
Term Loan Facility B2 B3 B- CCC+
Senior Notes B2 B3 B- CCC+
Management of Market Risk
The Company is exposed to interest rate risk on its variable debt and price risk
on its fixed-rate debt. At December 31, 2019 , the Company's variable-interest
borrowings were $471 million , or approximately 51.1%, of the Company's total
debt.
The Company assesses market risk based on changes in interest rates utilizing a
sensitivity analysis that measures the potential loss in earnings, fair values
and cash flows based on a hypothetical 10% change in interest rates. Using this
sensitivity analysis, such changes would not have a material effect on interest
income or expense and cash flows and would change the fair values of fixed-rate
debt at December 31, 2019 by approximately $19 million .
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 many 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 that borrowings, sales, purchases, revenues, expenses or other transactions are not in the local currency of the subsidiary, the Company is exposed to currency risk and may enter into foreign exchange forward contracts to hedge the currency risk. The Company is primarily exposed to the currencies of the Canadian dollar and Mexican peso, and was exposed to the currency of the Polish Zloty until the sale of the Company's European printing business in the third quarter of 2018. The Company does not use derivative financial instruments for trading or speculative purposes. OTHER INFORMATION
Environmental, Health and Safety
For a discussion of certain environmental, health and safety issues involving the Company, refer to Note 12, Commitments and Contingencies, to the consolidated financial statements.
45
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Litigation and Contingent Liabilities
For a discussion of certain litigation involving the Company, refer to Note 12, Commitments and Contingencies, to the consolidated financial statements.
New Accounting Pronouncements and Pending Accounting Standards
Recently issued accounting standards and their estimated effect on the Company's consolidated financial statements are also described in Note 22, New Accounting Pronouncements, and throughout the notes to the consolidated financial statements.
Off-Balance Sheet Arrangements
The Company does not have off-balance sheet arrangements, financings or special purpose entities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of market risks that 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. As of
• Fixed rate debt outstanding of
interest rate of 8.75%; and
• Variable rate debt outstanding of
is comprised primarily of
and $249 million outstanding on the Revolving Credit Facility.
For the year ended December 31, 2019 , the Term Loan and the Revolving Credit
Facility had current weighted-average interest rates of 7.73% and 5.47%,
respectively. Refer to Debt Issuances, included in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
Note 13, Debt, for more information. A hypothetical 10% change in interest rates
in the near term would not have a material effect on interest expense or cash
flows. A hypothetical 10% adverse change in interest rates in the near term
would change the fair value of fixed rate debt at December 31, 2019 , by
approximately $19 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. 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 intoU.S. dollars in preparing the Company's consolidated balance sheets. As ofDecember 31, 2019 , the Company's foreign subsidiaries had net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk of$34 million . The potential decrease in net current assets as ofDecember 31, 2019 , from a hypothetical 10% adverse change in quoted foreign currency exchange rates in the near term would be approximately$3 million . This sensitivity analysis assumes a parallel shift in all major foreign currency exchange rates verses theU.S. dollar. Exchange rates rarely move in the same direction relative to theU.S. dollar due to positive and negative correlations of the various global currencies. This assumption may overstate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency. 46 -------------------------------------------------------------------------------- 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. 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, taking into consideration the prospective customer's financial condition, 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$12 million as ofDecember 31, 2019 . The Company has a large, diverse customer base and does not have a high degree of concentration with any single customer account. During the year endedDecember 31, 2019 , the Company's largest customer accounted for less than 10% 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 in the near term could result in significant future charges. Commodity Risk The primary raw materials used by the Company are paper and ink. 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. To reduce price risk caused by market fluctuations, the Company has incorporated price adjustment clauses in certain sales contracts. Although the Company is able to pass most commodity cost increases through to its customers, management believes a hypothetical 10% adverse change in the price of paper and other raw materials in the near term would have a significant effect on demand for the Company's products due to the increase in total costs to our customers. Management is not able to quantify the likely impact of such a change in raw material prices on the Company's consolidated statements of operations or cash flows.
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