The Quarto Group 40 years young Final results Media At the start of its 41st year of operations, Quarto delivered a strong FY15 performance, as indicated by January s pre-close update. Revenue and margin were both ahead, there was notable progress on debt reduction and a step-up in the dividend. With the activists off the share register as of November 2015 (their shares placed with a spread of institutional funds), the board structure is also now being normalised, with two independent non-executive appointments (one to take the chair). Investment in content, talent, sales and marketing and systems underpin the growth now coming through, with acquisitions likely to supplement organic progress. 21 March 2016 Price 256.0p Market cap 50m 1:$1.45 Net debt ($m) at end December 2015 59.5 Shares in issue 19.7m Free float 75.2% Code QRT Year end Revenue ($m) PBT* ($m) EPS* (c) 12/14 171.3 11.9 44.1 13.7 8.4 3.7 12/15 182.2 14.1 49.5 14.5 7.5 3.9 12/16e 187.0 15.0 53.1 15.3 7.0 4.1 12/17e 192.5 15.8 55.4 15.8 6.7 4.3 DPS (c) Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. Children s list delivers on promise P/E (x) Yield (%) Primary exchange Secondary exchange Share price performance LSE N/A The group is effectively a portfolio of portfolios and there is an inevitable divergence between performances of the underlying elements. Children s books were identified as a particular target for investment by CEO Marcus Leaver, who joined the group in 2012. This has been paying off handsomely, with the children s offer now making up 22% of publishing revenues. The FY15 numbers also benefited from the fashion for colouring books for adults, which the group s North American imprints latched on to at an early stage, building on its position in art instruction. The main drag on performance was Books and Gifts Direct, the distribution business in Australia and New Zealand, which suffered from the weakness in the local economy and earlier overstocking by the master franchisers, exacerbated by currency translation. % 1m 3m 12m Abs 13.3 14.5 48.8 Rel (local) 9.1 12.8 64.0 52-week high/low 267.5p 165.0p Business description The Quarto Group is the leading global illustrated book publisher and distribution group Investing in new titles, building IP for future sales Quarto has a clear emphasis on producing high-quality books, which then sell over an extended period, giving much higher levels of backlist sales than industry norms 61.4% in FY15, down slightly from 66.6% in FY14 but ahead in absolute terms. Furthermore, 28% of backlist sales in FY15 were of titles over three years old. The focus on backlist sales has rather overshadowed the scale of the investment in developing new titles ($34.9m in FY15), spread over a very large number of titles and not dependent on any particular imprint, genre or author. Valuation: Strong performance, discount persists November s institutional placing cemented Quarto s market rehabilitation, which has seen the share price climb by 49% in a year. Achievements in reducing absolute debt levels and the strong performance of acquisitions both reduce earlier potential areas of concern. The possibility of equity issuance for fund purchases may limit full closure of the discount to other smaller publishing companies, trading on an 11.2x FY16e P/E vs 7.0x for Quarto. Next events Annual Meeting 24 May 2016 Analysts Fiona Orford-Williams +44 (0)20 3077 5739 Bridie Barrett +44 (0)20 3077 5700 media@edisongroup.com Edison profile page The Quarto Group, Inc. is a research client of Edison Investment Research Limited
FY16 revised up, FY17 forecasts published We have revisited our forecasts in light of the detailed FY15 numbers. While the US numbers undoubtedly saw a boost from the colouring book phenomenon, it would be misleading to suggest that this has distorted the reported figures, as the first books went into production in 2013, with Zentangles, and is likely to morph into some other form of art instruction rather than vanish overnight. FY15 results were modestly ahead of our earlier projections and we have edged our FY16 forecasts upwards, predicated on a top line growth assumption of around 3%. Our new FY17e numbers anticipate a similar rate of progress. Exhibit 1: Revisions to numbers EPS (c) PBT ($m) EBITDA ($m) Old New % chg. Old New % chg. Old New % chg. 2015 47.6 49.8 +5 13.3 14.2 +7 34.9 37.0 +6 2016e 51.7 53.1 +3 14.6 15.0 +3 36.3 37.9 +4 2017e - 55.4 N/A - 15.8 N/A - 38.7 N/A Source: Company accounts, Edison Investment Research. Note: 2015: Old Edison estimates; New reported actuals. As had been indicated earlier in the year, Quarto s publishing business has become increasingly second half weighted, although the effect in 2015 was masked by the poorer outturn from the distribution business, Books and Gifts Direct. The three publishing divisions, between them generating 80% of group revenues, are now approximately weighted one-third: two-thirds between the half-years. Operating profits are even more heavily skewed to the second half. Exhibit 2: Half year breakdown and forecasts Year to December ($000s) H114 H214 2014 H115 H215 2015 2016e 2017e Quarto Publishing US 26,957 37,101 64,058 27,234 45,207 72,441 74,000 76,467 Quarto Publishing UK 7,624 13,853 21,477 7,582 15,183 22,765 23,500 24,350 Quarto Intl Co-Ed 12,645 30,031 42,676 15,106 35,041 50,147 51,850 53,146 Books & Gifts Direct ANZ 11,814 19,356 31,170 8,875 13,185 22,060 22,250 22,584 Quarto Hong Kong 6,526 6,737 13,263 7,417 7,335 14,752 15,400 15,930 Total revenue 65,566 107,078 172,644 66,214 107,078 182,165 187,000 192,477 Normalised operating profit Quarto Publishing US 2,188 4,448 6,636 1,812 7,072 8,884 9,028 9,176 Quarto Publishing UK 329 2,770 3,099 293 3,009 3,302 3,396 3,555 Quarto Intl Co-Ed 737 5,326 6,063-1,110 7,461 6,351 6,533 6,696 Books & Gifts Direct ANZ 585 2,382 2,967 413 1,200 1,613 1,780 1,863 Quarto Hong Kong 623 489 1112 799 688 1,487 1,448 1,474 Total operating profit 4,462 15,415 19,877 2,207 19,430 21,637 22,184 22,764 Corporate expenses -2,079-2,405-4,484-1,984-2,405-4,431-4,200-4,250 Norm op profit (post amort prod'n costs) 2,383 13,010 15,393 2,383 17,025 17,206 17,984 18,514 Operating margin Quarto Publishing US 8.12% 11.99% 10.36% 6.65% 15.64% 12.26% 12.20% 12.00% Quarto Publishing UK 4.32% 20.00% 14.43% 3.86% 19.82% 14.50% 14.45% 14.60% Quarto Intl Co-Ed 5.83% 17.74% 14.21% -7.35% 21.29% 12.66% 12.60% 12.60% Books & Gifts Direct ANZ 4.95% 12.31% 9.52% 4.65% 9.10% 7.31% 8.00% 8.25% Quarto Hong Kong 9.55% 7.26% 8.38% 10.77% 9.38% 10.08% 9.40% 9.25% Net interest -1,638-1,619-3,257-1,322-1,776-3,257-2,984-2,714 Pre-tax pre-goodwill & exceps 745 11,391 12,136 1,061 15,249 13,949 15,000 15,800 Source: Edison Investment Research, company accounts This seasonality should not be taken to imply that the group does not have visibility on its forward sales. It also has a clear idea on the commerciality of each title before it proceeds to print. Frontlist sales will reflect a multiple of prior year intellectual property spend, on a (product efficiency) ratio which has steadily improved over the last four years from 1.02x in 2012 up to 1.34x in the year just reported. Backlist sales have been running consistently in the $85-89m over the last three years, but should tick up in FY16 as the higher frontlist titles move across to the backlist. The Quarto Group 21 March 2016 2
Corporate changes signal next phase The shift around in the share register as the activists have moved on was sorted with a placing into the hands of institutional shareholders, as described in our note of November 2015. The sequence of changes at board level was completed with the changes announced alongside the final results. Tim Chadwick, who was brought in as Chairman in 2012, and Christopher Mills, who represented the previous activist shareholders, will both leave the board at the AGM in May. The new chairman designate is Peter Read, formerly chairman of KPMG s TMT practice. The other new non-executive is Marie Louise Windeler, who, like Peter Read, holds a number of non-executive positions and who was CEO of Hill & Knowlton. There are two other non-executive directors on the board, along with the CEO and CFO. Having looked extensively into moving the registration from the US state of Delaware, the costs of doing so, in money and in management time, rule out doing so. Operational progress continues Through all the changes, Quarto s publishing businesses have concentrated on their core function: publishing books that are beautiful, useful or both. More recently, the management focus has been on building the platforms and infrastructures that enable the publishing imprints to sell more smartly. This has involved investing in financial and publishing systems, the www.quartoknows.com website (which incorporates an ecommerce facility), and leveraging spend on common needs such as print. The drive to build sales in the children s category has been very successful, with both organic and acquisitional activity producing strong sales growth, with the category making up 22% of FY15 publishing revenues. Of the eight imprints, three were in-house (including the Frances Lincoln imprint, which has been reinvigorated), three have been start-ups and two, acquisitions. Two new children s imprints are being launched in the US, but there is a strong appetite to grow the US children s offer more rapidly, ie by acquisition. Wide-Eyed Editions, within Quarto Publishing UK, was launched in 2104 and has been particularly successful with its over-sized, beautifully illustrated and informative children s titles. It generated $2.3m of sales in its second year of operation. While the pay down of the debt remains a key objective, it is not an imperative that has to be pursued ahead of taking other opportunities. Last year s buy of Ivy Press (for 1.5m including debt, February 2015) has been far more positive than anticipated, contributing revenues of $8.2m and operating profit of $1.9m to the International Co-Editions (and group) numbers. This should provide a degree of comfort to the market that Quarto is unlikely to get caught up in any bidding wars for larger assets. It also has no ambition to take on imprints which need extensive resource to optimise, either in cash or in management time. Our model assumes no further substantive transactions and cash conversion of a little over 100% (FY15 was unusually high at 114%), resulting in a reduction of around $6m in the debt position. Although the debt level is still high, the multiple to EBITDA reduced from 4.9x in FY12 to 3.2x for FY15, with all covenants easily met. Managing the debt position has been done without compromise on investment in intellectual property, the lifeblood of the business, or in the systems to optimise the sales and marketing effort. The dividend (now declared in US$) has also been increased to reflect the good financial performance, giving an above-market and sector yield. The Quarto Group 21 March 2016 3
Exhibit 3: Financial summary Year end 31 December 2013 2014 2015 2016e 2017e Accounting basis IFRS IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 176,318 171,339 182,165 187,000 192,477 Cost of sales (111,807) (116,326) (122,803) (126,038) (129,730) Gross profit 64,511 55,013 59,362 60,962 62,748 EBITDA 15,418 17,025 18,395 19,174 19,704 Operating profit (before GW and except) 14,044 15,919 17,206 17,984 18,514 Amortisation of intangibles (434) (503) (724) (724) (724) Exceptionals (3,405) 566 (445) 0 0 Amortisation of pre-production costs (30,099) (30,933) (33,258) (34,128) (35,127) Operating profit (19,894) (14,951) (17,221) (16,867) (17,337) Net interest (4,443) (3,977) (3,098) (2,984) (2,714) Profit before tax (norm) 9,601 11,942 14,108 15,000 15,800 Profit before tax IFRS 5,762 12,005 12,939 14,276 15,076 Tax (1,416) (2,922) (3,685) (4,150) (4,480) Adjustment to tax for normalised earnings (1,013) (16) (645) 0 0 Minority charge (412) (310) (388) (375) (388) Profit after tax (norm.) 6,760 8,696 9,778 10,475 10,932 Profit after tax (FRS3) 3,934 8,773 8,866 9,751 10,208 Average number of shares outstanding (m) 19.7 19.7 19.7 19.7 19.7 EPS - normalised fully diluted (c) 37.7 44.1 49.5 53.1 55.4 EPS - IFRS (c) 20.0 44.5 45.0 49.5 51.8 Dividend per share (c) 12.3 13.7 14.5 15.3 15.8 EBITDA margin (%) 9% 10% 10% 10% 10% Operating margin (before GW and except) (%) 8% 9% 9% 10% 10% BALANCE SHEET Fixed assets 104,557 102,416 104,433 105,148 105,174 Intangible assets 42,358 42,025 41,622 41,648 41,674 Tangible assets 5,978 2,857 3,368 4,500 4,500 Investment in associates 56,221 57,534 59,443 59,000 59,000 Current assets 99,103 99,702 108,369 110,521 115,026 Intangible assets: pre-publication costs 0 0 0 0 0 Stocks 19,181 24,851 26,147 26,841 27,627 Debtors 56,043 51,741 57,163 58,680 60,399 Cash 23,879 23,110 25,059 25,000 27,000 Current liabilities (70,485) (144,919) (70,635) (73,525) (78,690) Creditors (53,882) (55,769) (65,635) (68,025) (70,690) Short-term borrowings (16,603) (89,150) (5,000) (5,500) (8,000) Long-term liabilities (83,229) (6,875) (87,127) (78,100) (70,100) Long-term borrowings (78,291) 0 (79,562) (73,000) (65,000) Other long-term liabilities (4,938) (6,875) (7,565) (5,100) (5,100) Net assets 49,946 50,324 55,040 64,044 71,410 CASH FLOW Operating cash flow 47,914 47,529 52,941 53,430 53,600 Net interest (4,701) (3,310) (2,749) (3,152) (2,882) Tax (2,087) (759) (1,981) (3,801) (4,233) Capex (28,805) (33,018) (36,882) (36,000) (36,000) Acquisitions/disposals 1,057 (2,008) (1,614) (1,618) 0 Financing 14 0 0 0 0 Dividends (2,427) (2,739) (2,346) (2,857) (3,004) Other (382) 0 0 0 19 Net cash flow 10,583 5,695 7,369 6,003 7,500 Opening net debt/(cash) 80,978 71,015 66,040 59,503 53,500 HP finance leases initiated 0 0 0 0 0 Loans acquired with acquisitions 0 0 0 0 0 Translation differences (620) (720) (832) 0 0 Closing net debt/(cash) 71,015 66,040 59,503 53,500 46,000 Source: Company accounts, Edison Investment Research The Quarto Group 21 March 2016 4
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