LSC COMMUNICATIONS, INC. The following is management's discussion and analysis of the financial condition ofLSC Communications, Inc. as ofMarch 31, 2020 andDecember 31, 2019 and the results of operations for the three months endedMarch 31, 2020 and 2019. This commentary should be read in conjunction with the condensed consolidated financial statements and accompanying notes included in Item 1, Condensed Consolidated Financial Statements. Refer to the Company's annual report on Form 10-K, as filed with theSecurities and Exchange Commission ("SEC") onMarch 2, 2020 , for management's discussion and analysis of the financial condition of the company as ofDecember 31, 2019 andDecember 31, 2018 , and the results of operations for the years endedDecember 31, 2019 , 2018 and 2017. Company Overview The principal business ofLSC Communications, Inc. , aDelaware corporation, and its direct or indirect wholly-owned subsidiaries ("LSC Communications ," "the Company," "we," "our" and "us") is to offer a broad scope of traditional and digital print, print-related services and office products.
Voluntary Reorganization under Chapter 11
As a result of the commencement of the Chapter 11 Cases, the Company's operations and ability to develop and execute its business plan are subject to the risks and uncertainties associated with the reorganization process under the Bankruptcy Code. Following the outcome of the Chapter 11 Cases, the amount and composition of the Company's assets, liabilities, officers and/or directors, and the description of the Company's operations, properties, liquidity and capital resources included in this quarterly report may be significantly different. DIP Financing
See Note 9, Debt, for information on the DIP Facility, which provides up to
Going Concern The accompanying condensed consolidated financial statements were prepared assuming that the Company will continue as a going concern and contemplate the continuity of our operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business. Our ability to continue as a going concern is contingent upon our ability to comply with the covenants of the DIP Credit Agreement described in Note 9, Debt, and our ability to implement, subject to theBankruptcy Court's approval, a restructuring plan, among other factors. While operating as debtors-in-possession under Chapter 11, we may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of theBankruptcy Court or as otherwise permitted in the ordinary course of business (and subject to restrictions in our debt agreements), for amounts other than those reflected in the accompanying condensed consolidated financial statements. Further, the restructuring plan could materially change the amounts and classifications of assets and liabilities reported in the condensed consolidated financial statements. 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 condensed consolidated financial statements included in this quarterly report on Form 10-Q 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. 32
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Coronavirus Pandemic ("COVID-19")
During and subsequent to the first quarter of 2020, the novel coronavirus strain, known as COVID-19, continues to spread across the globe at an increasing rate. Measures taken by governmental authorities and private actors to limit the spread of this virus may interfere with the ability of the Company's employees, suppliers, and other business providers to carry out their assigned tasks or supply materials at ordinary levels of performance relative to the conduct of the business which may cause a material curtailment to certain business operations. Moreover, as a large part of the Company's business involves sales of books and other products used in schools and school facilities, if COVID-19 related measures continue to result in widespread and lengthy school closings, the Company's condensed consolidated results of operations and financial condition will be adversely impacted. Books sold in retail stores have also been adversely impacted as both large chains and independent stores have been forced to close. Additionally, as COVID-19 has significantly impacted retailers' stores, distribution centers and supply chains, the Company expects to experience an adverse impact on our catalogs and office products businesses. Disruption across many other industries has also significantly impact demand for advertising, which is expected to result in page count and volume reductions in magazines. We continue to monitor the situation, to assess further possible implications to our business and customers, and to take actions in an effort to mitigate adverse consequences. The Company has expanded its work-from-home policy for its non-manufacturing employees, has focused on obtaining protective equipment and implementing social distancing and other policies for its manufacturing employees and continues to adhere to guidance issued by governmental authorities. The Company is unable to quantify the impact on our business at this time, but it could have a material adverse effect on our condensed consolidated financial statements in the future.
On
Segment Descriptions 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.
The Company's segment and product and service offerings are summarized below
Magazines, Catalogs and Logistics
The Magazines, Catalogs and Logistics segment primarily produces magazines and catalogs and provides logistics solutions to the Company and other third parties. The segment also provides certain other print-related services, including mail services. The segment has operations primarily in theU.S. The Magazines, Catalogs and Logistics segment is divided into two reporting units: magazines and catalogs; and logistics. Book The Book segment produces books for publishers primarily in theU.S. The segment also provides supply-chain management services and warehousing and fulfillment services, as well as e-book formatting for book publishers. Office Products
The Office Products segment manufactures and sells branded and private label products in five core categories: filing products, envelopes, note-taking products, binder products, and forms.
Mexico
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Other
The Other grouping consists of the following non-reportable segments: Directories and Print Management. Print Management provides outsourced print procurement and management services.
Corporate
Corporate consists of unallocated selling, general and administrative activities
and associated expenses including executive, legal, finance, communications,
certain facility costs and last in, first out ("LIFO") inventory provisions. In
addition, share-based compensation expense is included in Corporate and not
allocated to the operating segments.
Outlook
Competitive Environment
According to the December 2019 IBIS World industry report "Printing in the
U.S. ," estimated total annual printing industry revenue is approximately $80
billion , of which approximately $13 billion relates to our core segments of the
print market and an additional approximately $33 billion pertains to related
segments of the print market in which we are able to offer certain products.
Despite consolidation in recent years, including several acquisitions completed
by LSC Communications , the industry remains highly fragmented and LSC
Communications is one of the largest players in our segment of the print
market. The print and related services industry, in general, continues to have
excess capacity and LSC Communications remains diligent in proactively
identifying plant consolidation opportunities to keep our capacity in line with
demand. Across the Company's range of print products and services, competition
is based primarily on the ability to deliver products for the lowest total cost,
a factor driven not only by price, but also by materials and distribution
costs. We expect that prices for print products and services will continue to be
a focal point for customers in coming years.
Value-added services, such as LSC Communications' co-mail, logistics and supply
chain management offerings, enable customers to lower their total costs.
Technological changes, including the electronic distribution of documents and
data, online distribution and hosting of media content, and advances in digital
printing, print-on-demand and internet technologies, continue to impact the
market for our products and services.
The Company's product and service offerings have been impacted by the following:
• The impact of digital technologies has been felt in many print
products. Digital technologies have impacted printed magazines asadvertising spending continues to move from print to electronic media.
• Catalogs have experienced volume reductions as our customers allocate more
of their spending to online resources and also face competition from online
retailers resulting in retailer compression.
• The effect of COVID-19 in 2020 on the industries the Company services.
• The Company has seen an unprecedented drop in demand for magazines and
catalogs, with the faster pace of decline in demand primarily due to the
accelerated impact of digital disruption of demand for printed materials.
• Educational books within the college market continue to be impacted by
electronic substitution and other trends. The K-12 educational sector
continues to be focused on increasing digital distribution but there has
been inconsistent adoption across school systems.
• E-book substitution has impacted overall consumer print trade book volume,
although e-book adoption rates have stabilized and industry-wide print book
volume has been growing in recent years.
• Electronic communication and transaction technology has also continued to
drive electronic substitution in directory printing, in part driven by cost
pressures at key customers.
The future impact of technology on our business is difficult to predict;
however, it is likely to result in additional expenditures to restructure
impacted operations or develop new technologies. In addition, we have made
targeted acquisitions and investments in our existing business to offer
customers innovative services and solutions. Such acquisitions and investments
include the acquisitions of Print Logistics in 2018 and Clark Group , Quality
Park , Publishers Press , CREEL , Fairrington, and HudsonYards in 2017, which
expanded our logistics, printing, digital, office products, and premedia
capabilities, and Continuum in 2016, which expanded our print management
capabilities. These acquisitions and investments further secure our position as
a technology leader in the industry.
34
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Technological advancement and innovation continues to affect the overall demand
for most of the products in our Office Products segment. However, the overall
market for our products remains large and we believe share growth is
attainable. We compete against a range of both domestic and international
competitors in each of our product categories within the segment. Due to the
increasing percentage of private label products in the market, resellers have
created a highly competitive environment where purchasing decisions are based
largely on price, quality and the supplier's ability to service the customer. As
consumer preferences shift towards private label, resellers have increased the
pressure on suppliers to better differentiate their product offering, oftentimes
through product exclusivity, product innovation and development of private label
products. We have experienced robust growth within our e-commerce channel, where
a significant majority of our sales are branded products.
We have implemented a number of strategic initiatives to reduce our overall cost
structure and improve efficiency, including the restructuring, reorganization
and integration of operations and streamlining of administrative and support
activities. Future cost reduction initiatives are likely to include the
reorganization of operations and the consolidation of facilities. Implementing
such initiatives might result in future restructuring or impairment charges,
which may be substantial. We also review our operations and management structure
on a regular basis to appropriately balance risks and opportunities to maximize
efficiencies and to support our long-term strategic goals.
During late 2018 and early 2019, the Company performed a comprehensive review of
the Company's entire 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
are expected to be implemented over the next three years. While the Company
realized the benefits beginning in 2019 and expects to realize benefits at
various points over the next three years, the Company has incurred $15 million
of expense, of which $5 million was incurred during the three months ended March
31, 2020 , relating to the implementation of certain identified initiatives. As
the Company continues to implement the identified initiatives, the Company
expects to incur additional expense; however, the Company expects the resulting
benefits (additional revenue and/or cost savings) to significantly exceed the
additional expense.
Raw Materials
We negotiate with suppliers to maximize our purchasing efficiencies. The primary
raw materials we use in our printed products are paper and ink. We negotiate
with paper suppliers to maximize our purchasing efficiencies and use a wide
variety of paper grades and formats. In addition, a substantial amount of paper
used in our printed products is supplied directly by customers. Variations in
the cost and supply of certain paper grades used in the manufacturing process
may affect our consolidated financial results. Generally, customers directly
absorb the impact of changing prices on customer-supplied paper. For paper that
we purchase, we have historically passed most changes in price through to our
customers. We entered into a paper consignment agreement at the end of 2019
that will encompass substantially all of LSC Communications' purchased paper by
mid-2020 to reduce our working capital.
Contractual arrangements and industry practice should support our continued
ability to pass on any future paper price increases, but there is no assurance
that market conditions will continue to enable us to successfully do so. Higher
paper prices and tight paper supplies may have an impact on customers' demand
for printed products. We also resell waste paper and other print-related
by-products and may be impacted by changes in prices for these by-products.
We use a wide variety of ink formulations and colors in our manufacturing
processes. Variations in the cost and supply of certain ink formulations may
affect our consolidated financial results. We have undertaken various strategic
initiatives to try to mitigate any foreseeable supply disruptions with respect
to our ink requirements, including entering into a long term supply arrangement
with a single supplier for a substantial portion of our ink supply. Certain
contractual protections exist in our relationship with such supplier, such as
price and quality protections and an ability to seek alternative sources of ink
if the supplier breaches or is unable to perform certain of its obligations,
which are intended to mitigate the risk of ink-related supply disruptions.
The primary materials used in the Office Products segment are paper, steel and
polypropylene substrates. We negotiate with leading paper, plastic and steel
suppliers to maximize our purchasing efficiencies. All of these materials are
available from a number of domestic and international suppliers and we are not
dependent upon any single supplier for any of these materials. We believe that
adequate supply is available for each of these materials for the foreseeable
future, although higher paper prices may have an impact on demand for our
products.
Changes in material prices, including paper, may impact the Company's operating
margins as there may be a lag between when the Company experiences the changes
and when they are absorbed by our customers.
35
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Except for our long-term supply arrangement regarding ink and paper consignment
agreement, we do not consider ourselves to be dependent upon any single vendor
as a source of supply for our businesses, and we believe that sufficient
alternative sources for the same, similar or alternative products are available.
Changes in the price of raw materials, crude oil and other energy costs impact
our manufacturing costs. Crude oil and energy prices continue to be volatile.
Should prices increase, we generally cannot pass on to customers the impact of
higher energy prices on our manufacturing costs. We do enter into fixed price
contracts for a portion of our natural gas purchases to mitigate the impact of
changes in energy prices. We cannot predict sudden changes in energy prices and
the impact that possible future changes in energy prices might have upon either
future operating costs or customer demand and the related impact either will
have on the Company's condensed consolidated statements of operations, balance
sheets and cash flows.
Pension Benefit Plans
The funded status of the Company's pension benefit plans is dependent upon many
factors, including returns on invested assets and the level of certain market
interest rates. Market conditions may lead to changes in the discount rates
(used to value the year-end benefit obligations of the plans) and the market
value of the securities held by the plans, which could significantly increase or
decrease the funded status of the plans. The Company reviews its actuarial
assumptions on an annual basis as of December 31 . Based on current estimates,
the Company expects to make cash contributions of approximately $6 million to
its pension benefit plans for the full year in 2020, of which $1 million has
been contributed during the three months ended March 31, 2020 .
Beginning in the first quarter of 2020, the Company changed the method of
accounting for the market-related value of assets for a class of assets within
the U.S. Qualified Plan and Non-Qualified plans. The change in accounting method
was retrospectively applied to periods in 2017, 2018 and 2019. Refer to Note 1,
Overview and Basis of Presentation, for more information.
Based on the fair value of assets and the estimated discount rate used to value
benefit obligations as of March 31, 2020 , the Company estimates the unfunded
status of the pension benefit plans to be approximately $113 million compared to
$162 million at December 31, 2019 .
See Note 11, Retirement Plans, for more information on the Company's pension benefit plans.
Significant Accounting Policies
There have been no changes to the Company's significant accounting policies
disclosed in the annual report on Form 10-K for the year-ended
36
--------------------------------------------------------------------------------FINANCIAL REVIEW
In the financial review that follows, the Company discusses its condensed consolidated balance sheets, statements of operations, cash flows and certain other information. This discussion should be read in conjunction with the Company's condensed consolidated financial statements and the related notes.
Results of Operations for the three months ended
The following table shows the results of operations for the three months endedMarch 31, 2020 and 2019, which reflects the results of the acquired businesses from the relevant acquisition dates: Three Months Ended March 31, 2020 2019 $ Change % Change (in millions, except percentages) Net sales$ 701 $ 845 $ (144 ) (17.0 %) Cost of sales 616 735 (119 ) (16.2 %) Cost of sales as a % of net sales 87.9 % 87.0 % Selling, general and administrative expenses (exclusive of depreciation and amortization) 75 85 (10 ) (11.8 %) Selling, general and administrative expenses as a % of net sales 10.7 % 10.1 % Restructuring, impairment and other charges-net 26 13 13 100.0 % Depreciation and amortization 27 31 (4 ) (12.9 %) (Loss) from operations$ (43 ) $ (19 ) $ (24 ) 126.3 %
Condensed Consolidated Results
Net sales for the three months endedMarch 31, 2020 were$701 million , a decrease of$144 million , or 17.0%, compared to the three months endedMarch 31, 2019 . Net sales were impacted by lower volume in magazines, catalogs and book products and a$41 million decrease in pass-through paper sales.
Total cost of sales decreased
As a percentage of net sales, cost of sales increased from 87.0% for the three
months ended
Selling, general and administrative expenses decreased$10 million , or 11.8%, for the three months endedMarch 31, 2020 compared to the three months endedMarch 31, 2019 , primarily due to higher expenses in 2019 related to the previously terminated merger agreement, lower volume and cost control initiatives.
For the three months ended
• Net other restructuring charges of
costs, expenses to move equipment, costs associated with new revenue
opportunities and cost savings initiatives implemented in 2019; and
• Employee termination costs of
employees, of whom 197 were terminated as of or prior to
primarily related to the closure of one facility closure in the Office
Products segment.
For the three months ended
• Net other restructuring charges of
related to facility costs and costs associated with new revenue
opportunities and cost savings initiatives implemented during the quarter;
37
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• Employee termination costs of
employees, of whom 16 were terminated as of or prior to
primarily related to the closure of one facility in the Magazines, Catalogs
and Logistics segment; and
•
associated with facility closings in the Magazines, Catalogs and Logistics
segment.
Depreciation and amortization decreased $4 million to $27 million for the three
months ended March 31, 2020 compared to the three months ended March 31, 2019 ,
due to decreased capital spending in recent years compared to historical levels.
Three Months Ended
March 31,
2020 2019 (1) $ Change % Change
(in millions, except percentages)
Interest expense-net $ 18 $ 19 $ (1 ) (5.3 %)
Settlement of retirement benefit obligations - 132 (132 ) (100.0 %)
Investment and other (income)-net (10 ) (8 ) (2 ) 25.0 %
Refer to Note 11, Retirement Plans, for information on the non-cash settlement
charge related to retirement benefit obligations. Investment and other
(income)-net primarily relates to the Company's pension benefit plans in both
years.
Three Months Ended
March 31,
2020 2019 (1) $ Change
(in millions, except percentages)
Net (loss) before income taxes
1 (37 ) 38
Effective income tax rate (2.7 %) 22.7 %
The effective income tax rate for the three months ended March 31, 2020 was
(2.7)% compared to 22.7% for the three months ended March 31, 2019 . The
effective income tax rate for the three months ended March 31, 2020 reflects the
company's limited ability to benefit U.S. results as the Company has a valuation
allowance recorded on its U.S. deferred tax assets.
The effective income tax rate for the three months ended March 31, 2019 reflects
the impact of nondeductible merger costs and share-based compensation awards
that either lapsed or vested.
(1) As Adjusted - Refer to Note 1, Overview and Basis of Presentation, for information on restated balances.
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.
Magazines, Catalogs and Logistics
Three Months Ended
March 31,
2020 2019 Change
(in millions, except percentages)
Net sales $ 327 $ 403 $ (76 )
(Loss) from operations (35 ) (31 ) (4 )
Operating margin (10.7 %) (7.7 %) (300) bps
Restructuring, impairment and other
charges-net 11 11 -
38
-------------------------------------------------------------------------------- Net sales for the Magazines, Catalogs and Logistics segment for the three months endedMarch 31, 2020 were$327 million , a decrease of$76 million , or 18.9%, compared to the three months endedMarch 31, 2019 . The Magazines, Catalogs and Logistics segment's net sales decreased primarily due to lower volume in magazines, catalogs and logistics and a$28 million decrease in pass-through paper sales. The change in Magazines, Catalogs and Logistics segment loss from operations and operating margins was primarily due to lower volume, partially offset by cost control initiatives. Book Three Months Ended March 31, 2020 2019 Change (in millions, except percentages) Net sales $ 204 $ 260 $ (56 ) (Loss) income from operations (9 ) 13 (22 ) Operating margin (4.4 %) 5.0 % (940 bps) Restructuring, impairment and other charges-net 3 1 2 Net sales for the Book segment for the three months endedMarch 31, 2020 were$204 million , a decrease of$56 million , or 21.4%, compared to the three months endedMarch 31, 2019 , primarily due to lower volume in educational and digitally-printed books and a$9 million decrease in pass-through paper sales.
The decrease in the operating income and margins was driven by lower volume and higher restructuring, impairment and other charges.
Office Products
Three Months Ended
March 31,
2020 2019 Change
(in millions, except percentages)
Net sales $ 112 $ 119 $ (7 )
Income from operations 7 8 (1 )
Operating margin 6.3 % 6.7 % (40) bps
Restructuring, impairment and other
charges-net 2 - 2
Net sales for the Office Products segment for the three months ended March 31,
2020 were $112 million , a decrease of $7 million , or 5.6%, compared to the three
months ended March 31, 2019 , largely as a result of lower volume in envelopes
and notetaking products, partially offset by higher volume in filing products.
The decrease in Office Products segment income from operations and operating
margin was primarily due to higher restructuring, impairment and other charges
and lower volume, partially offset by cost control initiatives.
Mexico
Three Months Ended
March 31,
2020 2019 Change
(in millions, except percentages)
Net sales $ 23 $ 24 $ (1 )
Income from operations 3 3 -
Operating margin 13.0 % 12.5 % 50 bps
39
-------------------------------------------------------------------------------- Net sales for theMexico segment were$23 million for the three months endedMarch 31, 2020 , a decrease of$1 million or 3.6%, compared to the three months endedMarch 31, 2019 . There were no significant changes to net sales or income from operations for the three months endedMarch 31, 2020 compared to the same period in 2019. Other Three Months Ended March 31, 2020 2019 Change (in millions, except percentages) Net sales $ 35$ 39 $ (4 ) Income from operations 3 1 2 Operating margin 8.6 % 2.5 % 610 bps Net sales for the Other grouping for the three months endedMarch 31, 2020 were$35 million , a decrease of$4 million , or 10.6%, compared to the three months endedMarch 31, 2019 , primarily due to a$4 million decrease in pass-through paper sales and lower directories volume.
The increase in income from operations and change in operating margins was primarily due to cost control initiatives and mix of work.
Corporate
The following table summarizes unallocated operating expenses and certain items impacting comparability within the activities presented as Corporate:
Three Months Ended
March 31,
2020 2019 Change
(in millions)
Total operating expenses $ 12 $ 13 $ (1 )
Significant components of total operating
expenses:
Restructuring, impairment and other charges-net 10 1 9
Share-based compensation expenses 1 3 (2 )
Expenses related to acquisitions, merger agreement
and dispositions - 7 (7 )
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
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.
40
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Non-GAAP adjusted EBITDA excludes restructuring, impairment and other
charges-net, share-based compensation expense, settlement of retirement benefit
obligations, and expenses related to acquisitions, merger agreement and
dispositions. In the first quarter of 2020, the Company began including
share-based compensation expense as a non-GAAP measure. As the share-based
compensation expense recorded in the current period represents expense for
previously issued grants that will vest at a lower share price than originally
expensed, management determined that share-based compensation expense represents
a non-GAAP measure. Share-based compensation expense was $1 million and $3
million during the three months ended March 31, 2020 and 2019, respectively. The
reconciliation for the three months ended March 31, 2019 below has been restated
to reflect this change.
A reconciliation of GAAP net income to non-GAAP adjusted EBITDA for the three
months ended
Three Months Ended
March 31,
2020 2019 (1)
(in millions)
Net (loss) $ (52 ) $ (125 ) Restructuring, impairment and other charges-
net 26 13 Share-based compensation expense 1 3 Settlement of retirement benefit obligations - 132
Expenses related to acquisitions, merger
agreement and dispositions - 7 Depreciation and amortization 27 31 Interest expense-net 18 19 Income tax expense (benefit) 1 (37 ) Non-GAAP adjusted EBITDA$ 21 $ 43
The adjustments to arrive at non-GAAP adjusted EBITDA are summarized below:
• Restructuring, impairment and other charges-net: Refer to Results of
Operations for the Three Months Ended March 31, 2020 as Compared to the
Three Months Ended March 31, 2019 for information on the charges.
• Share-based compensation expense: The Company incurred
million of expenses during the three months ended
respectively, in relation to its share-based compensation plans. There were
no new plans granted in 2020.
• Settlement of retirement obligations: Refer to Note 11, Retirement Plans,
for more information on the settlement charges.
• Expenses related to acquisitions, merger agreement and dispositions: The
three months ended
related to the previously terminated merger agreement.
(1) As Adjusted - Refer to Note 1, Overview and Basis of Presentation, for information on restated balances.
LIQUIDITY AND CAPITAL RESOURCES
The following sections describe the Company's cash flows for the three months
ended
Three Months Ended
March 31,
2020 2019
(in millions)
Net cash (used in) operating activities
(31 )
Net cash provided by financing
activities 2 46
41
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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$39 million for the three months endedMarch 31, 2020 compared to$24 million for the three months endedMarch 31, 2019 . The change was primarily due to a decrease in sales volume, an increase in restructuring payments and an increase in prepaid expenses, partially offset by improvements in timing of customer payments received and vendor payments made and by a decrease in inventory.
Cash Flows from Investing Activities
Net cash used in investing activities for the three months endedMarch 31, 2020 was$9 million compared to$31 million for the same period in 2019. The decrease was primarily due to$17 million of lower capital expenditures during the three months endedMarch 31, 2020 compared to the same period in 2019.
Cash Flows from Financing Activities
Net cash provided by financing activities for the three months endedMarch 31, 2020 was$2 million compared to$46 million for the same period in 2019. There was minimal financing activity during the three months endedMarch 31, 2020 compared to the following significant activity during the three months endedMarch 31, 2019 : •$67 million of net proceeds from credit facility borrowings; •$11 million in payments of current maturities and long-term debt; and •$9 million of dividends paid. Dividends
As a result of the DIP Credit Agreement, the Company is restricted from issuing dividend payments.
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 ofMarch 31, 2020 included$40 million in theU.S. and$16 million at 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 ofMarch 31, 2020 , 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 ofMarch 31, 2020 . 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"), which was reduced to$300 million per the amendment effective onAugust 5, 2019 . The debt issuance costs and original issue discount are being amortized over the life of the facilities using the effective interest method. 42 -------------------------------------------------------------------------------- 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 Amendments 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
TheAugust 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 . TheAugust 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.
Waiver, Forbearance Agreement and Fourth Amendment to Credit Agreement
Based on final results of operations for the year endedDecember 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 ofDecember 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. OnMarch 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 waived the defaults or events of default that occurred as a result of the financial covenant noncompliance onDecember 31, 2019 and prevented 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 endedMay 14, 2020 (such period, the "Forbearance Period"). As a result of the noncompliance as of December, 31, 2019, the Company annual report on Form 10-K disclosed there was substantial doubt about the Company's ability to continue as a going concern. 43
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Voluntary Reorganization under Chapter 11
The commencement of the Chapter 11 Cases constituted an event of default with respect to the Senior Notes, the Term Loan Facility and the Revolving Credit Facility (the "Debt Instruments"). The Debt Instruments provide that as a result of the commencement of the Chapter 11 Cases, the principal and interest due thereunder shall be immediately due and payable. Any efforts to enforce payment obligations under the Debt Instruments will be automatically stayed as a result of the commencement of the Chapter 11 Cases, and the creditors' right of enforcement in respect of the Debt Instruments are subject to the applicable provisions of the Bankruptcy Code.
Debtor-in-Possession Financing
As previously disclosed, onApril 15, 2020 (the "Closing Date"), the Company entered into a Superpriority Secured Debtor-in-Possession Credit Agreement (the "DIP Credit Agreement"), upon the entry of an interim order of theBankruptcy Court granting interim approval of the DIP Credit Agreement, among the Company, as borrower, the lenders from time to time party thereto (the "DIP Lenders") andBank of America, N.A . as administrative agent (in such capacity, the "DIP Agent"), pursuant to which the DIP Lenders committed to provide a senior secured superpriority debtor-in-possession credit facility in an aggregate principal amount not to exceed$100 million (the "DIP Facility"). The DIP Facility consists of (i) revolving loans not to exceed an aggregate amount of$55 million (the "Revolving Loans"), subject to the limitation in the next succeeding sentence, and (ii) letters of credit not to exceed an aggregate amount of$45 million , with$5 million of that amount being available for the issuance of new letters of credit (together with the Revolving Loans, the "DIP Loan Commitments"). During the interim period prior to the entry of a final order of theBankruptcy Court authorizing the DIP Facility (the "Final Order"), the Company's capacity to incur Revolving Loans is limited to an aggregate amount of up to$27.5 million . Borrowings under the DIP Facility bear interest at a rate per annum equal to, at the Company's option, either (i) the Alternate Base Rate (as defined in the DIP Credit Agreement) plus 5.75%, or (ii) LIBOR plus 6.75%. Upon an event of default under the DIP Credit Agreement (an "Event of Default"), an additional 2.00% may be added to the Interest Rate. In addition, the Company is required to pay (i) an unused line fee of 0.50% per annum (payable quarterly in arrears) on the average daily unused portion of the DIP Loan Commitments, (ii) a commitment fee of (x) 1.00% per annum on the DIP Loan Commitments, regardless of usage, plus (y)$100,000 per week for the first 20 weeks after the Closing Date, in each case, payable quarterly in arrears, (iii) a participation fee equal to 6.75% multiplied by the amounts available to be drawn under outstanding letters of credit, payable quarterly, and (iv) a fronting fee equal to 0.125% per annum on amounts available to be drawn under outstanding letters of credit, payable quarterly. Proceeds of the loans made under the DIP Facility may be used only for the following purposes: (i) working capital and other general corporate purposes, including the payment of professional fees and expenses, (ii) to pay the reasonable fees and expenses of the DIP Agent and the DIP Lenders (including the reasonable fees and expenses of counsel and financial advisors), (iii) to pay claims in respect of certain prepetition creditors, (iv) to repay indebtedness owed to holders of the Prepetition Priority Payment Obligations (as defined in the DIP Credit Agreement) (the "Prepetition Revolving Lenders"), and (v) making adequate protection payments to the Prepetition Revolving Lenders, the Prepetition Term Lenders and the Prepetition Secured Noteholders (each as defined in the DIP Credit Agreement). In connection with the DIP Credit Agreement, certain subsidiaries of the Company became parties to a guarantee agreement as guarantors (collectively, the "Guarantors," and together with the Company, the "DIP Credit Parties"). Each of the Guarantors is a debtor and debtor-in-possession in the Chapter 11 Cases. The Guarantors have guaranteed, on a joint and several basis, all of the obligations under the DIP Facility. To secure the obligations under the DIP Facility, the Company and the Guarantors have granted liens on substantially all of their assets, whether now owned or hereafter acquired. The DIP Facility will mature on the earliest of the following dates: (i) unless the Final Order is entered,May 15, 2020 , (ii) the date upon which any Plan of Reorganization (as defined in the DIP Credit Agreement) becomes effective, or (iii) the six-month anniversary following the Petition Date, provided that such maturity may be extended with the consent of the Required Lenders (as defined in the DIP Credit Agreement) to a date no later than nine months after the Petition Date. The DIP Credit Agreement contains representations, warranties and covenants that are customary for debtor-in-possession facilities of this type, including, but not limited to, certain case milestones, specified restrictions on indebtedness, liens, guarantee obligations, liquidations and dissolutions, sales of assets, leases, payment of dividends and other restricted payments, voluntary payments of other indebtedness, investments, loans and advances, transactions with affiliates, sale and leaseback transactions and compliance with case milestones. The DIP Credit Agreement also contains customary events of default for facilities of this type, including failure to achieve the milestones and the occurrence of certain events in the Chapter 11 Cases. 44 --------------------------------------------------------------------------------
The DIP Facility is subject to final approval by the
Other Information The Company's debt maturities as ofMarch 31, 2020 are shown in the following table: Debt Maturity Schedule Total 2020 2021 2022 2023 2024 Thereafter (in millions)
Borrowings under the Credit
Agreement$ 471 $ 471 $ - $ - $ - $ - $ - Senior secured notes 450 450 - - - - -
Finance lease obligations and
other borrowings 1 1 - - - - - Total (a)$ 922 $ 922 $ - $ - $ - $ - $ -
(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.
On March 4, 2020 , Moody's Investors Service ("Moody's) downgraded the Company's
credit ratings as noted below. There was no change to the outlook which remained
at negative. Refer below for S&P Global Rating ("S&P) under which the Company
has an issuer credit rating of CCC+.
Moody's S&P
Prior Rating New Rating Current Rating
Corporate family B3 Ca not applicable
Revolving Credit Facility Ba3 B3 B
Term Loan Facility B3 Ca CCC+
Senior Notes B3 Ca 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 March 31, 2020 , 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 March 31, 2020 by approximately $10 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. The Company does not use derivative financial instruments for
trading or speculative purposes.
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OTHER INFORMATION
Litigation and Contingent Liabilities
For a discussion of certain litigation involving the Company, see Note 8, Commitments and Contingencies, to the condensed consolidated financial statements.
New Accounting Pronouncements and Pending Accounting Standards
Recently issued accounting standards and their estimated effect on the Company's condensed consolidated financial statements are described in Note 15, New Accounting Pronouncements, and throughout the notes to the condensed consolidated financial statements.
Available Information The Company maintains an Internet website at www.lsccom.com where the Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on form 8-K and all amendments to those reports are available without charge, as soon as reasonably practicable following the time they are filed with, or furnished to, theSEC . The Principles of Corporate Governance of the Company's Board of Directors, the charters of the Audit, Human Resources and Corporate Responsibility and Governance Committees of the Board of Directors and the Company's Principles of Ethical Business Conduct are also available on the Investor Relations portion of www.lsccom.com, and will be provided, free of charge, to any stockholder who requests a copy. References to the Company's website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document. CAUTIONARY STATEMENT The Company has made forward-looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of the Company. Generally, forward-looking statements include information concerning possible or assumed future actions, events, or results of operations of the Company. These statements may include, or be preceded or followed by, the words "anticipates," "estimates," "expects," "projects," "forecasts," "intends," "plans," "continues," "believes," "may," "will," "goals" or variations of such words and similar expressions. Examples of forward-looking statements include, but are not limited to, statements, beliefs and expectations regarding our business strategies, market potential, future financial performance, dividends, results of pending legal matters, our goodwill and other intangible assets, price volatility and cost environment, our liquidity, our funding sources, expected pension contributions, capital expenditures and funding, our financial covenants, repayments of debt, off-balance sheet arrangements and contractual obligations, our accounting policies, general views about future operating results and other events or developments that we expect or anticipate will occur in the future. These forward-looking statements are subject to a number of important factors, including those factors disclosed in Item 1A, Risk Factors, in section Part II of this quarterly report on Form 10-Q, and Item 1A, Risk Factors, in section Part I in the Company's annual report on Form 10-K for the year endedDecember 31, 2019 , as filed with theSEC onMarch 2, 2020 , that could cause our actual results to differ materially from those indicated in any such forward-looking statements. These factors include, but are not limited to:
• our ability to generate sufficient liquidity to satisfy our obligations as
they become due;
• the competitive market for our products and industry fragmentation
affecting our prices;
• inability to improve operating efficiency to meet changing market conditions;
• changes in technology, including electronic substitution and migration of
paper based documents to digital data formats;
• the volatility and disruption of the capital and credit markets, and
adverse changes in the global economy;
• the effects of global market and economic conditions on our customers;
• the effect of economic weakness and constrained advertising; • uncertainty about future economic conditions;
• increased competition as a result of consolidation among our competitors;
• our ability to successfully integrate future acquisitions;
• factors that affect customer demand, including changes in postal rates,
postal regulations, delivery systems and service levels, changes in
advertising markets and customers' budgetary constraints;
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• the effects of seasonality on our core businesses; • the effects of increases in capital expenditures;
• changes in the availability or costs of key print production materials
(such as paper, ink, energy, and other raw materials), the tight labor
market, the availability of labor at our vendors or in prices received for
the sale of by-products;
• performance issues with key suppliers;
• our ability to maintain our brands and reputation;
• the retention of existing, and continued attraction of additional customers
and key employees, including management;
• the effect of economic and political conditions on a regional, national or
international basis;
• the effects of operating in international markets, including fluctuations
in currency exchange rates;
• changes in environmental laws and regulations affecting our business;
• the ability to gain customer acceptance of our new products and technologies;
• the effect of a material breach of or disruption to the security of any of
our or our vendors' systems;
• the failure to properly use and protect customer and employee information
and data;
• the effect of increased costs of providing health care and other benefits
to our employees;
• the effect of catastrophic events;
• the ability to maintain adequate payment terms with key vendors in light of
recent credit downgrades;
• the impact of tax legislation, including the CARES Act;
• increases in requirements to fund or pay withdrawal costs or required
contributions related to the Company's pension plans; and
• the effect of COVID-19 on our business.
Because forward-looking statements are subject to assumptions and uncertainties,
actual results may differ materially from those expressed or implied by such
forward-looking statements. Undue reliance should not be placed on such
statements, which speak only as of the date of this document or the date of any
document that may be incorporated by reference into this document.
Consequently, readers of this quarterly report on Form 10-Q should consider
these forward-looking statements only as the Company's current plans, estimates
and beliefs. The Company does not undertake and specifically declines any
obligation to publicly release the results of any revisions to these
forward-looking statements that may be made to reflect future events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events. The Company undertakes no obligation to
update or revise any forward-looking statements in this quarterly report on Form
10-Q to reflect any new events or any change in conditions or circumstances.
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