XNYS:QUAD Quad/Graphics Inc Class A Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                    to
Commission File Number 001-34806
QUAD/GRAPHICS, INC.
(Exact name of registrant as specified in its charter)
Wisconsin
 
39-1152983
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
N61 W23044 Harry's Way, Sussex, Wisconsin 53089-3995
 
(414) 566-6000
(Address of principal executive offices) (Zip Code)
 
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T  No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T  No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer T
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ¨  No T
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.
Class
 
Outstanding as of August 6, 2012
 
 
 
Class A Common Stock
 
32,678,480
 
 
 
Class B Common Stock
 
14,198,464
 
 
 
Class C Common Stock
 
245,353

 
 
 
 
 
QUAD/GRAPHICS, INC.
FORM 10-Q INDEX
For the Quarter Ended June 30, 2012

 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I — FINANCIAL INFORMATION

ITEM 1.
Condensed Consolidated Financial Statements (Unaudited)

QUAD/GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(UNAUDITED)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Net sales
 
 
 
 
 
 
 
Products
$
824.4

 
$
863.1

 
$
1,699.6

 
$
1,768.1

Services
109.8

 
114.1

 
224.2

 
231.5

Total net sales
934.2

 
977.2

 
1,923.8

 
1,999.6

 
 
 
 
 
 
 
 
Cost of sales
 
 
 
 
 
 
 
Products
656.4

 
665.2

 
1,343.1

 
1,362.2

Services
84.4

 
91.4

 
170.6

 
178.1

Total cost of sales
740.8

 
756.6

 
1,513.7

 
1,540.3

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
80.6

 
104.6

 
172.6

 
202.5

Depreciation and amortization
84.7

 
83.5

 
169.3

 
170.8

Restructuring, impairment and transaction-related charges
37.7

 
21.6

 
75.9

 
50.3

Total operating expenses
943.8

 
966.3

 
1,931.5

 
1,963.9

 
 
 
 
 
 
 
 
Operating income (loss) from continuing operations
(9.6
)
 
10.9

 
(7.7
)
 
35.7

 
 
 
 
 
 
 
 
Interest expense
20.7

 
29.3

 
42.1

 
59.1

 
 
 
 
 
 
 
 
Loss from continuing operations before income taxes and equity in earnings (loss) of unconsolidated entities
(30.3
)
 
(18.4
)
 
(49.8
)
 
(23.4
)
 
 
 
 
 
 
 
 
Income tax benefit
(10.3
)
 
(3.7
)
 
(44.1
)
 
(10.9
)
 
 
 
 
 
 
 
 
Loss from continuing operations before equity in earnings (loss) of unconsolidated entities
(20.0
)
 
(14.7
)
 
(5.7
)
 
(12.5
)
 
 
 
 
 
 
 
 
Equity in earnings (loss) of unconsolidated entities
(0.8
)
 
0.3

 
0.3

 
1.1

 
 
 
 
 
 
 
 
Net loss from continuing operations
$
(20.8
)
 
$
(14.4
)
 
$
(5.4
)
 
$
(11.4
)
 
 
 
 
 
 
 
 
Earnings (loss) from discontinued operations, net of tax

 
4.2

 
(3.2
)
 
(6.1
)
Gain on disposal of discontinued operations, net of tax

 

 
35.3

 

 
 
 
 
 
 
 
 
Net earnings (loss)
$
(20.8
)
 
$
(10.2
)
 
$
26.7

 
$
(17.5
)
 
 
 
 
 
 
 
 
Net earnings attributable to noncontrolling interests

 
(0.1
)
 
(0.1
)
 
(0.1
)
 
 
 
 
 
 
 
 
Net earnings (loss) attributable to Quad/Graphics common shareholders
$
(20.8
)
 
$
(10.3
)
 
$
26.6

 
$
(17.6
)
See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).


2


QUAD/GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
(in millions, except per share data)
(UNAUDITED)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Earnings (loss) per share attributable to Quad/Graphics common shareholders:
 
 
 
 
 
 
 
Basic and diluted:
 
 
 
 
 
 
 
Continuing operations
$
(0.44
)
 
$
(0.31
)
 
$
(0.12
)
 
$
(0.24
)
Discontinued operations

 
0.09

 
0.69

 
(0.13
)
Earnings (loss) per share attributable to Quad/Graphics common shareholders
$
(0.44
)
 
$
(0.22
)
 
$
0.57

 
$
(0.37
)
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
46.8

 
47.3

 
46.8

 
47.3

 
 
 
 
 
 
 
 
Amounts attributable to Quad/Graphics common shareholders:
 
 
 
 
 
 
 
Net loss from continuing operations
$
(20.8
)
 
$
(14.4
)
 
$
(5.4
)
 
$
(11.4
)
Net earnings attributable to noncontrolling interests

 
(0.1
)
 
(0.1
)
 
(0.1
)
Net loss from continuing operations attributable to Quad/Graphics common shareholders
$
(20.8
)
 
$
(14.5
)
 
$
(5.5
)
 
$
(11.5
)
 
 
 
 
 
 
 
 
Earnings (loss) from discontinued operations, net of tax
$

 
$
4.2

 
$
(3.2
)
 
$
(6.1
)
Gain on disposal of discontinued operations, net of tax

 

 
35.3

 

Net gain (loss) from discontinued operations, net of tax
$

 
$
4.2

 
$
32.1

 
$
(6.1
)
 
 
 
 
 
 
 
 
Net earnings (loss) attributable to Quad/Graphics common shareholders
$
(20.8
)
 
$
(10.3
)
 
$
26.6

 
$
(17.6
)
See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).



3


QUAD/GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(UNAUDITED)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Net earnings (loss)
$
(20.8
)
 
$
(10.2
)
 
$
26.7

 
$
(17.5
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
Foreign currency translation adjustments
(15.2
)
 
15.0

 
(2.2
)
 
27.8

Postretirement benefit plan amendment, net of tax
4.5

 

 
4.5

 

Pension and other postretirement benefit amortization, net of tax
(0.3
)
 
(0.5
)
 
(0.6
)
 
(1.0
)
Total other comprehensive income (loss)
(11.0
)
 
14.5

 
1.7

 
26.8

 
 
 
 
 
 
 
 
Total comprehensive income (loss)
(31.8
)
 
4.3

 
28.4

 
9.3

 
 
 
 
 
 
 
 
Less: comprehensive income attributable to noncontrolling interests

 
(0.1
)
 
(0.1
)
 
(0.1
)
 
 
 
 
 
 
 
 
Comprehensive income (loss) attributable to Quad/Graphics common shareholders
$
(31.8
)
 
$
4.2

 
$
28.3

 
$
9.2

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).



4


QUAD/GRAPHICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
(UNAUDITED)
 
June 30,
2012
 
December 31,
2011
ASSETS
 

 
 

Cash and cash equivalents
$
17.6

 
$
25.6

Receivables, less allowances for doubtful accounts of $68.3 at June 30, 2012 and $73.7 at December 31, 2011
531.9

 
656.1

Inventories
252.5

 
249.5

Prepaid expenses and other current assets
75.7

 
142.3

Deferred income taxes
70.6

 
86.7

Short-term restricted cash
17.2

 
8.5

Current assets of discontinued operations (Note 4)

 
72.6

 
 
 
 
Total current assets
965.5

 
1,241.3

 
 
 
 
Property, plant and equipment—net
2,023.2

 
2,123.3

Goodwill
787.3

 
787.1

Other intangible assets—net
262.1

 
295.6

Long-term restricted cash
47.3

 
67.4

Equity method investments in unconsolidated entities
68.2

 
69.4

Other long-term assets
49.0

 
46.2

Long-term assets of discontinued operations (Note 4)

 
104.9

 
 
 
 
Total assets
$
4,202.6

 
$
4,735.2

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 

 
 

Accounts payable
$
266.2

 
$
301.9

Amounts owing in satisfaction of bankruptcy claims
10.4

 
19.5

Accrued liabilities
341.0

 
393.9

Purchase price payable on business exchange transaction (Note 3)

 
62.4

Short-term debt and current portion of long-term debt
98.7

 
82.1

Current portion of capital lease obligations
10.3

 
20.7

Current liabilities of discontinued operations (Note 4)

 
48.4

 
 
 
 
Total current liabilities
726.6

 
928.9

 
 
 
 
Long-term debt
1,208.7

 
1,342.8

Unsecured notes to be issued
27.6

 
38.7

Capital lease obligations
20.5

 
24.9

Deferred income taxes
432.4

 
471.9

Other long-term liabilities
470.9

 
521.5

Long-term liabilities of discontinued operations (Note 4)

 
99.6

 
 
 
 
Total liabilities
2,886.7

 
3,428.3

 
 
 
 
Commitments and contingencies (Note 11)


 


 
 
 
 
Redeemable equity (Note 20)
3.5

 
3.5

 
 
 
 
Quad/Graphics common stock and other equity (Note 20)
 

 
 

Preferred stock

 

Common stock, Class A
1.0

 
1.0

Common stock, Class B
0.4

 
0.4

Common stock, Class C

 

Additional paid-in capital
979.4

 
984.2

Treasury stock, at cost
(283.7
)
 
(295.4
)
Retained earnings
650.6

 
650.2

Accumulated other comprehensive loss
(36.0
)
 
(37.7
)
 
 
 
 
Quad/Graphics common stock and other equity
1,311.7

 
1,302.7

 
 
 
 
Noncontrolling interests
0.7

 
0.7

 
 
 
 
Total common stock and other equity and noncontrolling interests
1,312.4

 
1,303.4

 
 
 
 
Total liabilities and shareholders' equity
$
4,202.6

 
$
4,735.2

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).


5


QUAD/GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(UNAUDITED)
 
Six Months Ended June 30,
 
2012
 
2011
OPERATING ACTIVITIES
 
 
 
Net earnings (loss)
$
26.7

 
$
(17.5
)
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
169.3

 
178.2

Impairment charges
14.1

 

Amortization of debt issuance costs
2.3

 
5.6

Stock-based compensation charges
6.9

 
4.6

Gain on disposal of discontinued operations, net of tax
(35.3
)
 

(Gain) loss on sales or disposal of property, plant and equipment
0.1

 
(0.2
)
Deferred income taxes
(25.5
)
 
9.4

Equity in earnings of unconsolidated entities
(0.3
)
 
(1.1
)
Dividends from unconsolidated entities

 
1.6

Changes in operating assets and liabilities—net of acquisitions
12.2

 
(63.9
)
 
 
 
 
Net cash provided by operating activities
170.5

 
116.7

 
 
 
 
INVESTING ACTIVITIES
 
 
 
Purchases of property, plant and equipment
(54.2
)
 
(98.5
)
Investment in ManipalTech (Note 3)
(18.1
)
 

Proceeds from the sale of property, plant and equipment
10.0

 
8.2

Transfers from restricted cash
11.4

 
17.3

Deposit refunded related to business exchange transaction (Note 3)
50.0

 

Purchase price payments on business exchange transaction (Note 3)
(4.2
)
 

Acquisition of business—net of cash acquired
(6.6
)
 

 
 
 
 
Net cash used in investing activities
(11.7
)
 
(73.0
)
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Payments of long-term debt
(35.9
)
 
(43.6
)
Payments of capital lease obligations
(15.9
)
 
(8.8
)
Borrowings on revolving credit facilities
65.1

 
389.5

Payments on revolving credit facilities
(142.6
)
 
(360.9
)
Bankruptcy claim payments on unsecured notes to be issued
(11.1
)
 
(8.0
)
Proceeds from issuance of common stock

 
1.6

Tax benefit on exercise of stock options

 
0.8

Payment of cash dividends
(23.4
)
 
(9.4
)
Payment of tax distributions

 
(4.2
)
 
 
 
 
Net cash used in financing activities
(163.8
)
 
(43.0
)
 
 
 
 
Effect of exchange rates on cash and cash equivalents
(3.0
)
 
(4.6
)
 
 
 
 
Net decrease in cash and cash equivalents
(8.0
)
 
(3.9
)
 
 
 
 
Cash and cash equivalents at beginning of period
25.6

 
20.5

 
 
 
 
Cash and cash equivalents at end of period
$
17.6

 
$
16.6

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).


6

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)


Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements for Quad/Graphics, Inc. and its subsidiaries (the "Company" or "Quad/Graphics") have been prepared by the Company pursuant to the rules and regulations for interim financial information of the United States Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been omitted pursuant to such SEC rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated annual financial statements as of and for the year ended December 31, 2011, and notes thereto included in the Company's latest Annual Report on Form 10-K filed with the SEC on February 29, 2012.

The Company's business is seasonal, with the majority of historical net sales and operating income recognized in the second half of the fiscal year. Seasonality is driven by increased magazine advertising page counts and retail inserts and catalogs primarily due to back-to-school and holiday related advertising and promotions. Within any year, seasonality could adversely impact the Company's cash flow and results of operations on a quarterly basis.

The financial information contained herein reflects all adjustments, in the opinion of management, necessary for a fair presentation of the Company's results of operations for the three and six months ended June 30, 2012 and 2011. All significant intercompany transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statements include estimates and assumptions of management that affect the amounts reported in the condensed consolidated financial statements. Actual results could differ from these estimates.

The results of operations of the Company's Canadian operations have been reported as discontinued operations for all periods presented. As the sale of the Canadian operations was completed on March 1, 2012, the corresponding Canadian assets and liabilities are no longer included in the condensed consolidated balance sheet at June 30, 2012. At December 31, 2011, the Canadian assets and liabilities were presented in accordance with the authoritative literature on assets held for sale. In accordance with the authoritative literature, the Company has elected to not separately disclose the cash flows related to the Canadian discontinued operations. See Note 4 for information about the Company's sale of the Canadian operations.

Note 2. Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board ("FASB") issued new guidance on testing goodwill for impairment. This new guidance gives entities, subject to certain conditions, the option of first performing a qualitative assessment to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. The Company adopted this guidance effective January 1, 2012. Annual impairment tests of goodwill are performed in the fourth quarter of each year. The adoption of this guidance is not expected to have a material impact on the Company's condensed consolidated financial position, results of operations or cash flows.

In May 2011, the FASB issued new guidance on fair value measurements. This new guidance amends the definition of fair value measurement principles and disclosure requirements to eliminate differences between GAAP and International Financial Reporting Standards. This new guidance requires new quantitative and qualitative disclosures about the sensitivity of recurring Level 3 measurement disclosures, as well as transfers between Level 1 and Level 2 of the fair value hierarchy. The Company adopted this guidance effective January 1, 2012. The adoption of this guidance impacted the Company's disclosures and had no impact on the Company's condensed consolidated financial position, results of operations or cash flows.



7

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Note 3. Acquisitions and Strategic Investments

2012 Acquisitions and Strategic Investments

On March 28, 2012, the Company entered into a strategic partnership with India-based Manipal Technologies Limited ("ManipalTech") whereby Quad/Graphics paid $18.1 million for a minority equity ownership interest in ManipalTech. ManipalTech is one of India's largest providers of printing services and supports clients' marketing, branding and communication needs through print services and technology solutions. The Company's investment in ManipalTech is accounted for as a cost method investment and is recorded within other long-term assets in the condensed consolidated balance sheet.

2011 Acquisitions and Strategic Investments

On July 12, 2011, the Company and Transcontinental Inc. ("Transcontinental") entered into a definitive agreement whereby Quad/Graphics acquired 100% of Transcontinental's Mexican operations in exchange for the Company's Canadian operations. Transcontinental's Mexican operations printed magazines, catalogs, retail inserts, books and other printed materials, and employed approximately 900 people among its three facilities in Azcapotzalco, Toluca and Xochimilco, Mexico. The Transcontinental Mexican operations are included within the International segment.

The Company completed the acquisition of Transcontinental's Mexican operations on September 8, 2011, and completed the sale of the Company's Canadian operations on March 1, 2012. See Note 4 for further discussion of the sale of the Canadian discontinued operations.

In connection with the acquisition of Transcontinental's Mexican operations, the definitive agreement required the Company to deposit 50.0 million Canadian dollars with Transcontinental until the Canadian operations sale was completed. The Company elected to hedge the foreign currency exchange rate exposure related to the 50.0 million Canadian dollar deposit by entering into short-term foreign currency forward exchange contracts. The Company hedged this foreign currency exposure until the March 1, 2012 sale of the Canadian net assets and refund of the 50.0 million Canadian dollar deposit occurred. During the six months ended June 30, 2012, $1.6 million of realized mark-to-market losses on the derivative contracts were offset by $1.6 million of transaction gains on translation of the foreign currency denominated deposit within selling, general and administrative expenses. The fair value determination of the foreign currency forward exchange contracts was categorized as Level 2 in the fair value hierarchy (see Note 15 for the definition of Level 2 inputs).

The Company's determination of the Mexican acquired operations' fair value was $63.6 million. Of the $63.6 million purchase price, $5.4 million was paid in cash ($1.2 million was paid in 2011 and $4.2 million was paid in 2012). The remaining purchase price of $58.2 million was satisfied by the exchange transaction of the Company's Canadian business.

This acquisition was accounted for using the acquisition method of accounting. The Company recorded the allocation of the purchase price to the acquired tangible and identifiable intangible assets and liabilities assumed based on their fair values as of the acquisition date. Goodwill has been recorded based on the amount by which the purchase price exceeds the fair value of the net assets acquired. The final purchase price allocation is as follows:

 
 
Purchase Price Allocation
Accounts receivable
 
$
15.3

Other current assets
 
11.9

Property, plant and equipment
 
35.7

Identifiable intangible assets
 
4.6

Other long-term assets
 
0.5

Accounts payable and accrued liabilities
 
(14.9
)
Other long-term liabilities
 
(0.6
)
Goodwill
 
11.1

Purchase price
 
$
63.6



8

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)


The purchase price allocation is based on valuations performed to determine the fair value of the net assets as of the acquisition date. The purchase price of $63.6 million was estimated by utilizing a discounted cash flow model, following an income approach that incorporates various assumptions including expected future revenue trends, profit margins, capital expenditures, working capital levels and a weighted-average cost of capital. The nonrecurring fair value measurement was classified as Level 3 in the valuation hierarchy (see Note 15 for the definition of Level 3 inputs). Purchased identifiable intangible assets will be amortized on a straight-line basis over six years. The results of operations of the acquired business have been included since the respective dates of acquisition in the accompanying condensed consolidated financial statements. Pro forma information related to the acquisition is not included because the impact on the Company's condensed consolidated results of operations is considered to be immaterial.

Note 4. Discontinued Operations

On March 1, 2012, the Company completed the sale of its Canadian operations to Transcontinental (see Note 3 for a description of the business exchange transaction). The gain on disposal of discontinued operations, net of tax, was determined as follows:

 
 
As of March 1, 2012
Fair value of the acquired Transcontinental Mexican operations
 
$
63.6

Cash paid to Transcontinental
 
(5.4
)
Net proceeds
 
$
58.2

Net assets of discontinued operations
 
(26.3
)
Cumulative translation adjustment of discontinued operations
 
3.4

Gain on disposal of discontinued operations, net of tax(1)
 
$
35.3

__________________________________
(1)
For tax purposes the disposal of discontinued operations resulted in a long-term capital loss, for which a deferred tax asset was recorded. An offsetting valuation allowance against the deferred tax asset was recorded to reflect the expected value at which the asset will be recovered.

The results of operations of the Canadian operations have been reflected as discontinued operations in the condensed consolidated financial statements for all periods presented. The following table summarizes the results of operations of the Canadian operations, which are included in the earnings (loss) from discontinued operations, net of tax in the condensed consolidated statements of operations for the three and six months ended June 30, 2012 and 2011:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Total net sales
$

 
$
93.3

 
$
32.2

 
$
173.2

 
 
 
 
 
 
 
 
Earnings (loss) from discontinued operations before income taxes

 
4.3

 
(3.2
)
 
(6.0
)
Income tax expense

 
0.1

 

 
0.1

Earnings (loss) from discontinued operations, net of tax
$

 
$
4.2

 
$
(3.2
)
 
$
(6.1
)



9

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

As a result of the March 1, 2012 sale of the Canadian operations, there were no net assets of discontinued operations at June 30, 2012. The following table summarizes the current and non-current assets and liabilities held for sale of the discontinued Canadian operations included in the condensed consolidated balance sheet at December 31, 2011:

 
 
December 31, 2011
Receivables—net
 
$
64.1

Inventories
 
7.5

Prepaid expenses and other current assets
 
1.0

Current assets of discontinued operations
 
72.6

 
 
 
Property, plant and equipment—net
 
71.8

Goodwill
 
20.9

Other intangible assets—net
 
12.2

Long-term assets of discontinued operations
 
104.9

 
 
 
Total assets
 
$
177.5

 
 
 
Accounts payable
 
$
15.0

Accrued liabilities
 
33.4

Current liabilities of discontinued operations
 
48.4

 
 
 
Other long-term liabilities
 
99.6

Long-term liabilities of discontinued operations
 
99.6

 
 
 
Total liabilities
 
$
148.0

 
 
 
Net assets of discontinued operations
 
$
29.5


Note 5. Restructuring, Impairment and Transaction-Related Charges

The Company recorded restructuring, impairment and transaction-related charges for the three and six months ended June 30, 2012 and 2011, as follows:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Employee termination charges
 
$
10.2

 
$
4.8

 
$
20.6

 
$
15.8

Impairment charges
 
5.7

 

 
14.1

 

Transaction-related charges
 
0.8

 
1.0

 
2.3

 
1.0

Integration costs
 
11.2

 
8.9

 
23.1

 
15.3

Other restructuring charges
 
9.8

 
6.9

 
15.8

 
18.2

Total
 
$
37.7

 
$
21.6

 
$
75.9

 
$
50.3


The costs related to these activities have been recorded on the condensed consolidated statements of operations as restructuring, impairment and transaction-related charges. See Note 21 for restructuring, impairment and transaction-related charges by segment.



10

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Restructuring Charges

The Company began a restructuring program in 2010 related to eliminating excess manufacturing capacity and properly aligning its cost structure as part of the integration of the July 2, 2010 World Color Press, Inc. ("World Color Press") acquisition. The Company has since expanded its restructuring program to include the cost reduction programs associated with the September 8, 2011 Transcontinental Mexico acquisition as well as other cost reduction programs.

During the six months ended June 30, 2012, the Company announced the closures of the Jonesboro, Arkansas plant and two plants in Mexico City, Mexico. Since 2010, the Company has announced a total of 15 plant closures and has reduced headcount by approximately 5,800. As a result of these restructuring programs, the Company recorded the following charges for the three and six months ended June 30, 2012 and 2011:

Employee termination charges of $10.2 million and $20.6 million during the three and six months ended June 30, 2012, respectively, and $4.8 million and $15.8 million during the three and six months ended June 30, 2011, respectively. The Company reduced its workforce through facility consolidations and involuntary separation programs.

Integration costs of $11.2 million and $23.1 million during the three and six months ended June 30, 2012, respectively, and $8.9 million and $15.3 million during the three and six months ended June 30, 2011, respectively. Integration costs were primarily related to preparing existing facilities to meet new production requirements resulting from work transferring from closed plants, as well as other costs related to the integration of the acquired companies. The integration costs during the six months ended June 30, 2011, are presented net of a $7.1 million gain on the collection of a note receivable for the June 2008 sale of World Color Press' European operations.

Other restructuring charges of $9.8 million and $15.8 million during the three and six months ended June 30, 2012, respectively, consisted of: (1) $3.2 million and $6.7 million, respectively, of vacant facility carrying costs, (2) $3.0 million and $5.2 million, respectively, of equipment and infrastructure removal costs from closed plants and (3) $3.6 million and $3.9 million, respectively, of lease exit charges. Other restructuring charges during the six months ended June 30, 2012, are presented net of a $2.4 million gain on the collection of a note receivable related to a settlement of a disputed pre-acquisition World Color Press note receivable. Other restructuring charges of $6.9 million and $18.2 million during the three and six months ended June 30, 2011, respectively, consisted of: (1) $2.6 million and $7.4 million, respectively, of vacant facility carrying costs, (2) $2.2 million and $4.8 million, respectively, of equipment and infrastructure removal costs from closed plants and (3) $2.1 million and $6.0 million, respectively, of lease exit charges.

The restructuring charges recorded are based on plans that have been committed to by management and are, in part, based upon management's best estimates of future events. Changes to the estimates may require future restructuring charges and adjustments to the restructuring liabilities. The Company expects to incur additional restructuring charges related to these and other initiatives in 2012.

Impairment Charges

As a result of plant closures related to capacity reduction restructuring initiatives, certain buildings and equipment are no longer utilized in production. The Company recognized impairment charges of $5.7 million and $14.1 million during the three and six months ended June 30, 2012, respectively, primarily related to the Company's closed Pila, Poland and Stillwater, Oklahoma facilities. The fair values of the impaired assets were determined by the Company to be Level 3 under the fair value hierarchy and were estimated based on broker quotes and internal expertise related to current marketplace conditions. These assets were written down to their estimated fair values of $3.4 million at the time of impairment. There were no impairment charges recognized during the three and six months ended June 30, 2011.

Transaction-Related Charges

The Company incurs transaction-related charges primarily consisting of professional service fees related to business acquisition and divestiture activities. The Company recognized transaction-related charges of $0.8 million and $2.3 million


11

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

during the three and six months ended June 30, 2012, respectively. The Company recognized transaction related charges of $1.0 million during the three and six months ended June 30, 2011. The transaction costs are expensed as incurred in accordance with the applicable accounting guidance on business combinations.

Reserves for Restructuring, Impairment and Transaction-Related Charges

Activity impacting the Company's reserves for restructuring, impairment and transaction-related charges for the six months ended June 30, 2012, was as follows:

 
Employee
Termination Charges
 
Impairment
Charges
 
Transaction-Related
Charges
 
Integration
Costs
 
Other
Restructuring
Charges
 
Total
Balance at December 31, 2011
$
9.3

 
$

 
$

 
$
18.2

 
$
26.7

 
$
54.2

Expense from continuing operations
20.6

 
14.1

 
2.3

 
23.1

 
15.8

 
75.9

Cash payments
(20.2
)
 

 
(2.0
)
 
(15.3
)
 
(19.4
)
 
(56.9
)
Non-cash adjustments

 
(14.1
)
 

 

 
(1.8
)
 
(15.9
)
Balance at June 30, 2012
$
9.7

 
$

 
$
0.3

 
$
26.0

 
$
21.3

 
$
57.3


These reserves are classified as accrued liabilities in the condensed consolidated balance sheets as the Company expects to complete these restructuring program actions within the next twelve months.

Note 6. Goodwill and Other Intangible Assets

Goodwill is tested annually for impairment as of October 31, or more frequently if events or changes in circumstances indicate that it is more likely than not that the fair value of a reporting unit is below its carrying value. Goodwill at June 30, 2012 did not include any accumulated impairment losses. No indications of impairment have been identified during the six months ended June 30, 2012. As a result, no goodwill impairment was recorded during the six months ended June 30, 2012 or 2011.

Activity impacting the Company's goodwill for the six months ended June 30, 2012, was as follows:

 
United States Print and Related Services
 
International
 
Total
Balance at December 31, 2011
$
757.4

 
$
29.7

 
$
787.1

Translation adjustment

 
0.2

 
0.2

Balance at June 30, 2012
$
757.4

 
$
29.9

 
$
787.3




12

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

The components of other intangible assets at June 30, 2012 and December 31, 2011, were as follows:

 
June 30, 2012
 
December 31, 2011
 
Weighted
Average
Amortization
Period (years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
and Foreign
Exchange
 
Net Book
Value
 
Weighted
Average
Amortization
Period (years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
and Foreign
Exchange
 
Net Book
Value
Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trademarks, patents, licenses and agreements
5
 
$
10.4

 
$
(9.4
)
 
$
1.0

 
5
 
$
10.7

 
$
(9.6
)
 
$
1.1

Customer relationships
6
 
383.6

 
(127.7
)
 
255.9

 
6
 
383.6

 
(95.7
)
 
287.9

Capitalized software
5
 
4.1

 
(2.1
)
 
2.0

 
5
 
4.1

 
(1.7
)
 
2.4

Acquired technology
5
 
8.0

 
(4.8
)
 
3.2

 
5
 
8.0

 
(4.0
)
 
4.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total finite-lived intangible assets
 
406.1

 
(144.0
)
 
262.1

 
 
 
406.4

 
(111.0
)
 
295.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other indefinite-lived intangible assets
 

 

 

 
 
 
0.2

 

 
0.2

Total
 
$
406.1

 
$
(144.0
)
 
$
262.1

 
 
 
$
406.6

 
$
(111.0
)
 
$
295.6


Amortization expense for other intangible assets was $16.4 million and $33.2 million for the three and six months ended June 30, 2012, respectively, and $16.5 million and $32.6 million for the three and six months ended June 30, 2011, respectively. The following table outlines the estimated future amortization expense related to intangible assets as of June 30, 2012:

Remainder of 2012
$
33.6

2013
65.7

2014
65.0

2015
64.4

2016
33.0

2017
0.4

Total
$
262.1


Note 7. Inventories

The components of the Company's inventories at June 30, 2012 and December 31, 2011 were as follows:

 
June 30,
2012
 
December 31,
2011
Raw materials and manufacturing supplies
$
161.1

 
$
124.9

Work in process
44.1

 
72.0

Finished goods
47.3

 
52.6

Total
$
252.5

 
$
249.5




13

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Note 8. Property, Plant and Equipment

The components of the Company's property, plant and equipment at June 30, 2012 and December 31, 2011 were as follows:

 
June 30,
2012
 
December 31,
2011
Land
$
138.4

 
$
140.9

Buildings
905.7

 
930.1

Machinery and equipment
3,388.5

 
3,398.2

Other
203.2

 
201.7

Construction in progress
30.7

 
23.0

 
4,666.5

 
4,693.9

Less: accumulated depreciation
(2,643.3
)
 
(2,570.6
)
Total
$
2,023.2

 
$
2,123.3


Other consists of computer equipment, vehicles, furniture and fixtures, leasehold improvements and communication related equipment.

The Company recognized depreciation expense of $68.3 million and $136.1 million for the three and six months ended June 30, 2012, respectively, and $67.0 million and $138.2 million for the three and six months ended June 30, 2011, respectively.

Assets Held for Sale from Continuing Operations

Certain closed facilities are considered held for sale. The net book value of the assets held for sale from continuing operations was $11.5 million and $14.3 million as of June 30, 2012 and December 31, 2011, respectively. These assets were valued at their fair value, less the estimated costs to sell. Assets held for sale from continuing operations are included in prepaid expenses and other current assets in the condensed consolidated balance sheets.

Note 9. Restricted Cash

The components of the Company's restricted cash at June 30, 2012 and December 31, 2011 were as follows:

 
June 30,
2012
 
December 31,
2011
Defeasance of unsecured notes to be issued (see Note 12)
$
64.3

 
$
75.4

Other
0.2

 
0.5

Total restricted cash
$
64.5

 
$
75.9

Less: short-term restricted cash
(17.2
)
 
(8.5
)
Long-term restricted cash
$
47.3

 
$
67.4


Note 10. Equity Method Investments in Unconsolidated Entities

The Company has a 49% ownership interest in Plural Editora e Gráfica ("Plural"), a commercial printer based in São Paulo, Brazil, and a 50% ownership interest in Quad/Graphics Chile S.A. ("Chile"), a commercial printer based in Santiago, Chile. The Company's ownership interest in Plural and Chile is accounted for using the equity method of accounting for all periods presented. The Company's equity earnings of Plural's and Chile's operations are recorded in the line item entitled equity in earnings (loss) of unconsolidated entities in the Company's condensed consolidated statements of operations, and is included within the International segment.



14

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

The combined condensed statements of operations for Plural and Chile for the three and six months ended June 30, 2012 and 2011 are presented below:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Net sales
$
43.6

 
$
49.1

 
$
96.2

 
$
103.1

Operating income (loss)
(1.9
)
 
1.6

 
1.9

 
3.8

Net earnings (loss)
(2.2
)
 
0.6

 
0.1

 
2.0


Note 11. Commitments and Contingencies

Commitments

The Company had firm commitments of $12.0 million to purchase press and finishing equipment at June 30, 2012.

Litigation

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

Environmental Reserves

The Company is subject to various laws, regulations and government policies relating to health and safety, to the generation, storage, transportation, and disposal of hazardous substances, and to environment protection in general. The Company provides for expenses associated with environmental remediation obligations when such amounts are probable and can be reasonably estimated. Such reserves are adjusted as new information develops or circumstances change. The environmental reserves are not discounted. The Company believes it is in compliance with such laws, regulations and government policies in all material respects. Furthermore, the Company does not anticipate that maintaining compliance with such environmental statutes will have a material impact upon the Company's competitive or consolidated financial position.

Note 12. World Color Press Insolvency Proceedings

The Company continues to manage the bankruptcy claim settlement process for the Quebecor World Inc. ("QWI") bankruptcy proceedings in the United States and Canada (QWI changed its name to "World Color Press Inc." upon emerging from bankruptcy on July 21, 2009). To the extent claims are allowed, the holders of such claims are entitled to receive recovery, with the nature of such recovery dependent upon the type and classification of such claims. In this regard, with respect to certain types of claims, the holders thereof are entitled to receive cash and/or unsecured notes, while the holders of certain other types of claims are entitled to receive a combination of Quad/Graphics common stock and cash, in accordance with the terms of the World Color Press acquisition agreement.

With respect to claims asserted by the holders thereof as being entitled to a priority cash recovery, the Company has estimated that approximately $10.4 million and $19.5 million of such recorded claims have yet to be paid as of June 30, 2012 and December 31, 2011, respectively, and this obligation is classified as amounts owing in satisfaction of bankruptcy claims in the condensed consolidated balance sheets.

With respect to unsecured claims held by creditors of the operating subsidiary debtors of Quebecor World (USA) Inc. (the "Class 3 Claims"), each allowed Class 3 Claim will be entitled to receive an unsecured note in an amount not to exceed 50% of such creditor's allowed Class 3 Claim, provided, however, that the aggregate principal amount of all such unsecured notes cannot exceed $75.0 million. In the event that the total of all allowed Class 3 Claims exceeds $150.0 million, each creditor holding an allowed Class 3 Claim will receive its pro rata share of $75.0 million of the unsecured notes issued, together with accrued interest and a 5% prepayment redemption premium thereon (the total of which is $89.2 million). In connection with the World Color Press acquisition, the Company was required to deposit the maximum potential payout to the Class 3


15

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Claim creditors of $89.2 million with a trustee, and that amount will remain with the trustee until either (1) it is paid to a creditor for an allowed Class 3 Claim or (2) upon all Class 3 Claims being resolved any excess amount will revert to the Company. In the six months ended June 30, 2012, $11.1 million was paid to Class 3 Claim creditors. At June 30, 2012, $64.3 million remains and is classified as restricted cash in the condensed consolidated balance sheets (see Note 9). Based on the Company's analysis of the outstanding claims, the Company has recorded a liability, classified as unsecured notes to be issued in the condensed consolidated balance sheet, of $27.6 million at June 30, 2012.

 
Restricted Cash
 
Unsecured Notes
to be Issued
Balance at December 31, 2011
$
75.4

 
$
38.7

Class 3 Claim payments during 2012
(11.1
)
 
(11.1
)
Balance at June 30, 2012
$
64.3

 
$
27.6


While the liabilities recorded for any bankruptcy matters are based on management's current assessment of the amount likely to be paid, it is not possible to identify the final amount of priority cash claims or the amount of Class 3 Claims that will ultimately be allowed by the U.S. Bankruptcy Court. Therefore, amounts owing in satisfaction of bankruptcy claims on the condensed consolidated balance sheet could be materially higher than the amounts estimated, which would require additional cash payments to be made for the amount exceeding the Company's estimate. Amounts payable related to the unsecured notes could reach the maximum aggregate principal amount of $75.0 million, which would not require an additional cash payment as the maximum potential exposure has already been funded in trust, but would require additional liability and expense to be recorded as the Company's estimate of total Class 3 Claim payments to be made is $52.5 million ($24.9 million paid out and $27.6 million remaining estimated liability as of June 30, 2012). In light of the substantial number and amount of claims filed, the claims resolution process will take considerable time to complete.

Note 13. Debt

Long-term debt consisted of the following as of June 30, 2012 and December 31, 2011:

 
June 30,
2012
 
December 31,
2011
Master note and security agreement
$
583.4

 
$
616.0

Term loan A—$450.0 million
450.0

 
450.0

Term loan B—$200.0 million
197.6

 
198.6

Revolving credit facility—$850.0 million

 
85.0

International term loan—$72.1 million
62.4

 
65.9

International revolving credit facility—$14.9 million
9.9

 
6.7

Other
4.1

 
2.7

Total debt
$
1,307.4

 
$
1,424.9

Less: short-term debt and current portion of long-term debt
(98.7
)
 
(82.1
)
Long-term debt
$
1,208.7

 
$
1,342.8


Based upon the interest rates available to the Company for borrowings with similar terms and maturities, the fair value of the Company's total debt was approximately $1.2 billion at June 30, 2012. The fair value determination of the Company's total debt was categorized as Level 2 in the fair value hierarchy (see Note 15 for the definition of Level 2 inputs).



16

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

As of June 30, 2012, the Company's various lending arrangements included certain financial covenants (all financial terms, numbers and ratios are as defined in the Company's debt agreements). Among these covenants, the Company was required to maintain the following as of June 30, 2012 (for each covenant, the most restrictive measurement has been included below):

On a rolling twelve-month basis, the total leverage ratio, defined as total consolidated debt to consolidated EBITDA (as defined in the debt agreement), shall not exceed 3.50 to 1.00 (for the twelve months ended June 30, 2012, the Company's leverage ratio was 2.16 to 1.00).
 On a rolling twelve-month basis, the minimum interest coverage ratio, defined as consolidated EBITDA to consolidated cash interest expense, shall not be less than 3.25 to 1.00 (for the twelve months ended June 30, 2012, the Company's interest coverage ratio was 7.30 to 1.00).
On a rolling twelve-month basis, the fixed charge coverage ratio, defined as consolidated EBITDA and rent expense to interest and rent expense, shall not be less than 1.50 to 1.00 (for the twelve months ended June 30, 2012, the Company's fixed charge coverage ratio was 3.52 to 1.00).
Consolidated net worth of at least $745.8 million plus 40% of positive consolidated net income cumulatively for each year (as of June 30, 2012, the Company's consolidated net worth under the most restrictive covenant per the various debt agreements was $1.25 billion).

In addition to those covenants, the $1.5 billion debt financing agreement entered into on July 26, 2011 also includes certain limitations on acquisitions, indebtedness, liens, dividends and repurchases of capital stock. If the Company's total leverage ratio is greater than 3.00 to 1.00 (total leverage ratio as defined in the debt financing agreement), the Company is prohibited from making greater than $120.0 million of annual dividend payments, capital stock repurchases and certain other payments. If the total leverage ratio is less than 3.00 to 1.00, there are no such restrictions. As of June 30, 2012, the Company was in compliance with all financial covenants in its debt agreements.

Note 14. Income Taxes

The Company records income tax expense on an interim basis. The estimated annual effective income tax rate is adjusted quarterly and items discrete to a specific quarter are reflected in tax expense for that interim period. The actual effective income tax rate for the interim period can differ from the statutory tax rate, as it reflects changes in valuation allowances due to expected current year earnings or loss and other discrete items, such as changes in the liability for unrecognized tax benefits related to establishment and settlement of income tax exposures.

During the six months ended June 30, 2012, the Company's liability for unrecognized tax benefits was reduced by $70.8 million, primarily related to settlement of Internal Revenue Service ("IRS") audits. In connection with the settlements, the Company recorded an income tax benefit of $31.2 million in the condensed consolidated statement of operations. The Company does not anticipate a material change in total unrecognized tax benefits within the next 12 months.

Note 15. Financial Instruments and Fair Value Measurements

Certain assets and liabilities are required to be recorded at fair value on a recurring basis, while other assets and liabilities are recorded at fair value on a nonrecurring basis, generally as a result of acquisitions or impairment charges. Fair value is determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The Company records the fair value of its forward contracts and pension plan assets on a recurring basis. Nonrecurring fair value measurements during the quarter were not significant. The fair value of cash and cash equivalents, receivables, inventories, restricted cash, accounts payable, accrued liabilities and amounts owing in satisfaction of bankruptcy claims approximate their carrying values as of June 30, 2012, and December 31, 2011. See Note 13 for further discussion on the fair value of the Company's debt. GAAP also classifies the inputs used to measure fair value into the following hierarchy:

Level 1:
Quoted prices in active markets for identical assets or liabilities.



17

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Level 2:
Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

Level 3:
Unobservable inputs for the asset or liability. There are no Level 3 recurring measurements of assets or liabilities as of June 30, 2012. In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company is required to record certain assets and liabilities at fair value on a nonrecurring basis, generally as a result of acquisitions or the remeasurement of assets resulting in impairment charges. See Note 5 for further discussion on impairment charges recorded as a result of the remeasurement of certain long-lived assets as of June 30, 2012.

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

The Company periodically enters into natural gas forward purchase contracts to hedge against increases in commodity costs. During the three and six months ended June 30, 2012 and 2011, the Company's commodity contracts qualified for the exception related to normal purchases and sales as the Company takes delivery in the normal course of business.

The Company settled the short-term foreign currency forward exchange contract to hedge exchange rate exposure on the 50.0 million Canadian dollars deposit related to the Transcontinental Mexico acquisition on March 1, 2012 (see Note 3). There were no open foreign currency exchange contracts as of June 30, 2012. For the three and six months ended June 30, 2012 and 2011, the impact on the condensed consolidated statements of operations of hedge ineffectiveness was not material.

Note 16. Other Long-Term Liabilities

Other long-term liabilities consisted of the following as of June 30, 2012 and December 31, 2011:

 
June 30,
2012
 
December 31,
2011
Single employer pension and postretirement obligations
$
277.6

 
$
300.9

Multiemployer pension plans—withdrawal liability
80.4

 
83.5

Tax-related liabilities
13.1

 
30.7

Employee-related liabilities
44.1

 
45.0

Other
55.7

 
61.4

Total
$
470.9

 
$
521.5


Note 17. Pension and Other Postretirement Benefits

The Company sponsors various funded and unfunded pension plans for a portion of its full-time employees in the United States. Benefits are generally based upon years of service and compensation. These plans are funded in conformity with the applicable government regulations. The Company funds at least the minimum amount required for all qualified plans using actuarial cost methods and assumptions acceptable under government regulations. In addition to pension benefits, the Company provides certain healthcare and life insurance benefits for some retired employees.



18

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

The components of the net pension expense and net postretirement benefits income from continuing operations for the three and six months ended June 30, 2012 and 2011, are as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Pension expense
 
 
 
 
 
 
 
Service cost
$

 
$
0.1

 
$
0.1

 
$
0.2

Interest cost
7.8

 
8.5

 
15.6

 
17.0

Expected return on plan assets
(6.8
)
 
(6.9
)
 
(13.6
)
 
(13.8
)
Net periodic pension benefit expense
1.0

 
1.7

 
2.1

 
3.4

Settlement loss

 

 
0.1

 

Net pension expense
$
1.0

 
$
1.7

 
$
2.2

 
$
3.4

 
 
 
 
 
 
 
 
Postretirement benefits income
 
 
 
 
 
 
 
Service cost
$
0.1

 
$
0.1

 
$
0.2

 
$
0.2

Interest cost
0.2

 
0.4

 
0.5

 
0.8

Amortization of deferred gains, net
(0.5
)
 
(0.8
)
 
(1.0
)
 
(1.6
)
Net postretirement benefits income
$
(0.2
)
 
$
(0.3
)
 
$
(0.3
)
 
$
(0.6
)

During the six months ended June 30, 2012, the Company announced the elimination of life insurance coverage for all current and future retirees in all locations and the elimination of reimbursements of medical costs for certain retirees. Due to the plan amendments, the plan obligations as of June 30, 2012, were reduced by $7.4 million. There was no impact to the postretirement benefits income in the six months ended June 30, 2012.

During the six months ended June 30, 2012, the Company made the following contributions and benefits payments to its defined benefit pension and postretirement plans in its continuing operations:

 
 
Six Months Ended
 
 
June 30, 2012
Contributions on qualified pension plans
 
$
18.3

Settlement payments on non-qualified pension plans
 
3.2

Benefit payments on non-qualified pension plans
 
0.6

Benefit payments on postretirement plans
 
0.3

Total benefit plan payments
 
$
22.4


Multiemployer Pension Plans

The Company is in process of withdrawing from all significant multiemployer pension plans ("MEPPs") and, during 2011, replaced these union sponsored “promise to pay in the future” defined benefit plans with a Company sponsored “pay as you go” defined contribution plan. The two MEPPs, the Graphic Communications International Union - Employer Retirement Fund (“GCIU”) and the Graphic Communications Conference of the International Brotherhood of Teamsters National Pension Fund (“GCC”), are significantly underfunded, and will require the Company to pay a withdrawal liability to fund its pro rata share of the underfunding as of the plan year the full withdrawal was completed.

The Company has received notices of withdrawal and demand for payment letters for both the GCIU and GCC plans, and is in the process of determining the final withdrawal payment with both MEPPs' administrators. During this process the Company began making monthly payments as requested by the MEPPs and as required by the Employee Retirement Income Security Act, although such payments do not waive the Company's rights to object to the withdrawal liabilities submitted by the GCIU and GCC plan administrators. As of June 30, 2012, the Company has reserved $94.6 million as its estimate of the total MEPPs withdrawal liability, of which $80.4 million is recorded in other long-term liabilities, $8.7 million is recorded in


19

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

accrued liabilities and $5.5 million is recorded in unsecured notes to be issued in the condensed consolidated balance sheet. This estimate may change depending on the final agreement with the MEPPs' administrators.

Note 18. Earnings (Loss) Per Share Attributable to Quad/Graphics Common Shareholders

Basic earnings (loss) per share attributable to Quad/Graphics common shareholders is computed by dividing net earnings (loss) attributable to Quad/Graphics common shareholders by the weighted average common shares outstanding of 46.8 million for the three and six months ended June 30, 2012, respectively, and 47.3 million shares for the three and six months ended June 30, 2011, respectively. The calculation of a diluted earnings per share amount includes the effect of any dilutive equity incentive instruments. The Company uses the treasury stock method to calculate the effect of outstanding dilutive equity incentive instruments, which requires the Company to compute total proceeds as the sum of (1) the amount the employee must pay upon exercise of the award, (2) the amount of unearned stock-based compensation costs attributed to future services and (3) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award. Equity incentive instruments for which the total employee proceeds from exercise exceed the average fair value of the same equity incentive instrument over the period have an anti-dilutive effect on earnings per share during periods with net earnings from continuing operations, and accordingly, the Company excludes them from the calculation. Due to the net loss from continuing operations attributable to Quad/Graphics common shareholders incurred during the three and six months ended June 30, 2012 and 2011, the assumed exercise of all equity incentive instruments was anti-dilutive and, therefore, not included in the diluted earnings (loss) per share attributable to Quad/Graphics common shareholders calculation.



20

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

Reconciliations of the numerator and the denominator of the basic and diluted per share computations for the Company's common stock, including the impact of discontinued operations, for the three and six months ended June 30, 2012 and 2011, are summarized as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Numerator:
 
 
 
 
 
 
 
Net loss from continuing operations
$
(20.8
)
 
$
(14.4
)
 
$
(5.4
)
 
$
(11.4
)
Net earnings attributable to noncontrolling interests

 
(0.1
)
 
(0.1
)
 
(0.1
)
Net loss from continuing operations attributable to Quad/Graphics common shareholders
$
(20.8
)
 
$
(14.5
)
 
$
(5.5
)
 
$
(11.5
)
 
 
 
 
 
 
 
 
Earnings (loss) from discontinued operations, net of tax
$

 
$
4.2

 
$
(3.2
)
 
$
(6.1
)
Gain on disposal of discontinued operations, net of tax

 

 
35.3

 

Net gain (loss) from discontinued operations, net of tax
$

 
$
4.2

 
$
32.1

 
$
(6.1
)
 
 
 
 
 
 
 
 
Net earnings (loss) attributable to Quad/Graphics common shareholders
$
(20.8
)
 
$
(10.3
)
 
$
26.6

 
$
(17.6
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic weighted average number of common shares outstanding for all classes of common shares
46.8

 
47.3

 
46.8

 
47.3

Plus: effect of dilutive equity incentive instruments

 

 

 

Diluted weighted average number of common shares outstanding for all classes of common shares
46.8

 
47.3

 
46.8

 
47.3

 
 
 
 
 
 
 
 
Net earnings (loss) per share attributable to Quad/Graphics common shareholders:
 
 
 
 
 
 
 
Basic and diluted:
 
 
 
 
 
 
 
Continuing operations
$
(0.44
)
 
$
(0.31
)
 
$
(0.12
)
 
$
(0.24
)
Discontinued operations

 
0.09

 
0.69

 
(0.13
)
Earnings (loss) per share attributable to Quad/Graphics common shareholders
$
(0.44
)
 
$
(0.22
)
 
$
0.57

 
$
(0.37
)
 
 
 
 
 
 
 
 
Cash dividends paid per common share for all classes of common shares
$
0.25

 
$
0.20

 
$
0.50

 
$
0.20


Note 19. Equity Incentive Programs

The Company recognizes compensation expense, based on estimated grant date fair values, for all share-based awards issued to employees and non-employee directors using the Black-Scholes option pricing model. The total compensation expense recognized related to all equity incentive programs was $3.3 million and $6.9 million for the three and six months ended June 30, 2012, respectively, and $2.0 million and $4.6 million for the three and six months ended June 30, 2011, respectively, and was recorded in selling, general and administrative expenses in the condensed consolidated statements of operations. The Company recognizes compensation costs for only those awards expected to vest on a straight-line basis over the requisite service period of the awards, which is generally the vesting term. The Company estimated the number of awards expected to vest based, in part, on historical forfeiture rates and also based on management's expectations of employee turnover within the specific employee groups receiving each type of award. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods, if actual forfeitures differ from those estimates.

For grants beginning January 1, 2011, the shareholders of the Company approved the Quad/Graphics Inc. 2010 Omnibus Incentive Plan ("Omnibus Plan") for two complimentary purposes: (1) to attract and retain outstanding individuals to serve as directors, officers and employees and (2) to increase shareholder value. Concurrent with the July 2, 2010 closing of


21

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

the World Color Press acquisition, an additional 2.3 million shares of Class A stock were approved for issuance under the Company's Omnibus Plan. The Omnibus Plan replaced the 1999 Nonqualified Stock Option Plan and the 1990 Stock Option Plan and, as of January 1, 2011, all equity grants are made from the Omnibus Plan. Within the framework of the Omnibus Plan, the Company's board of directors approved the form of a new stock option award agreement, a restricted stock award agreement, a restricted stock unit award agreement and a deferred stock unit award agreement. Each equity incentive instrument granted has an exercise price of no less than 100% of the fair market value of the class A stock on the date of grant.

As of June 30, 2012, there are 1.0 million shares available for issuance under the Omnibus Plan.

Stock Options

Stock options vest over four years, with no vesting in the first year and one-third vesting upon the second, third and fourth anniversary dates. As defined in the individual grant agreements, acceleration of vesting may occur under a change in control, death, disability or normal retirement of the grantee. Options expire no later than the tenth anniversary of the grant date, twenty-four months after termination for death, thirty-six months after termination for normal retirement or disability and 90 days after termination of employment for any other reason. Excluding options granted on November 18, 2011, options are not credited with dividend declarations. Stock options are typically granted only to employees.

The Company granted 448,154 stock options under the Omnibus Plan on both January 1, 2012 and 2011 with a weighted average fair value of $2.25 and $13.19 for the grants, respectively. The fair value of each stock option grant is estimated on the date of grant with the following weighted average assumptions for the six months ended June 30, 2012 and 2011:

 
 
Six Months Ended June 30,
 
 
2012
 
2011
Expected volatility
 
36.7
%
 
36.0
%
Risk-free interest rate
 
1.3
%
 
2.3
%
Expected life (years)
 
7.0

 
7.0

Dividend yield
 
7.1
%
 
2.0
%

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

Compensation expense recognized related to stock options was $2.6 million and $5.0 million for the three and six months ended June 30, 2012, respectively, and $1.6 million and $3.2 million for the three and six months ended June 30, 2011, respectively. Total future compensation expense for all stock options granted as of June 30, 2012 is estimated to be $25.5 million. Estimated future compensation expense is $5.1 million for 2012, $10.1 million for 2013, $10.1 million for 2014, and $0.2 million for 2015.



22

QUAD/GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012
(In millions, except share and per share data and unless otherwise indicated)

The following table is a summary of the stock option activity for the six months ended June 30, 2012:

 
Shares Under
Option
(thousands)
 
Weighted Average
Exercise
Price
 
Weighted Average
Remaining
Contractual Term
(years)
 
Aggregate
Intrinsic Value
(millions)
Outstanding at December 31, 2011
3,984

 
$
21.09

 
7.7
 
$
1.1

Granted
448

 
14.14

 

 


Exercised

 

 
 
 


Cancelled/forfeited/expired
(2
)
 
29.68

 
 
 


Outstanding at June 30, 2012
4,430

 
$
20.35

 
7.4
 
$
1.2

 
 
 
 
 
 
 
 
Vested and expected to vest at June 30, 2012
4,086

 
$
20.28

 
7.4
 
$
1.2

Exercisable at June 30, 2012
1,875

 
$
18.46

 
7.2
 
$
0.8


The intrinsic value of options exercisable and options outstanding at June 30, 2012 and 2011 is based on the fair value of the stock price. There were no option exercises in the three and six months ended June 30, 2012. Cash received from option exercises was $0 and $1.6 million for the three and six months ended June 30, 2011, respectively. Share-based compensation activity for the three and six months ended June 30, 2012 and 2011 is noted below:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Total intrinsic value of stock options exercised
$

 
$

 
$

 
$
3.1

Cash received from stock option exercises

 

 

 
1.6

Total fair value of stock options vested

 

 

 
5.4


Restricted Stock, Restricted Stock Units and Deferred Stock Units

Restricted stock ("RS") and restricted stock unit ("RSU") awards consist of shares or the rights to shares of the Company's class A stock which are awarded to employees of the Company. The awards are restricted such that they are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer by the employee. RSU awards are typically granted to eligible employees outside of the United States. As defined in the individual grant agreements, acceleration of vesting may occur under a change in control, or death, disability or normal retirement of the grantee. Grantees receiving RS grants are able to exercise full voting rights and receive full credit for dividends during the vesting period. All such dividends will be paid to the RS grantee within 45 days of full vesting. Grantees receiving RSUs granted prior to January 1, 2012 are not entitled to vote and do not earn dividend equivalents. Grantees receiving RSUs on or after January 1, 2012 are not entitled to vote but do earn dividends equivalents. Upon vesting, RSUs will be settled either through cash payment equal to the fair market value of the RSUs on the vesting date or through issuance of Company class A stock.

The following table is a summary of RS and RSU award activity for the six months ended June 30, 2012:

 
Restricted Stock
 
Restricted Stock Units
 
Shares
(thousands)
 
Weighted-
Average
Grant Date
Fair Value
Per Share
 
Weighted-
Average
Remaining
Contractual
Term (years)
 
Units
(thousands)
 
Weighted-
Average
Grant Date
Fair Value
Per Share
 
Weighted-
Average
Remaining
Contractual
Term (years)
Nonvested at December 31, 2011
110.2

 
$
41.21

 
2.0

 
10.1

 
$
37.81

 
2.0

Granted
310.7

 
14.34

 

 
15.8

 
14.34

 

Vested

 

 

 

 

 

Forfeited
(3.0
)
 
41.26

 

 
(3.5
)
 
38.86

 

Nonvested at June 30, 2012
417.9

 
$
21.23

 
2.3