QRT.L Regulatory News (QRT)

THE QUARTO GROUP, INC

Interim Results

for the Six Months Ended 30 June 2012

Quarto (Full List: QRT.L), one of the largest international co-edition book publishers based in London, announces its interim results for the six months ended 30 June 2012.

·; Results ahead of expectations during the traditionally quieter half of the year

·; Operating profit up 6% to $3.9 million (2011: $3.7 million)

·; Revenue up 1% to $73.2 million (2011: $72.5 million)

·; Growth in digital, including e-book, revenues slowed in second quarter, but rose overall by 87% and, at $1.6 million (2011: $0.86 million) were 2.2% of sales.

·; Book Publishing segment revenues increased to $53.4 million (2011: $51.6 million), benefitting from acquisition last year of Frances Lincoln. The operating profit was $4.9 million (2011: $4.3 million), growing by 13%

·; International Co-Edition Book Segment revenues down by 5% to $19.8 million (2011: $21.0 million), and operating profit declined by 33% to $0.53 million (2011: $0.79 million), reflecting slowing business in continental Europe and continued caution in English-language markets.

·; Net debt declined to $87.8 million (2011: $90.3 million), and debt facility successfully refinanced

Commenting on the results, Chairman and Chief Executive Officer, Laurence Orbach said:

"Performance exceeded expectations.... a good achievement given the challenging economic environment globally."

For further information please contact:

The Quarto Group Inc 020 7700 9004

Laurence Orbach, Chairman and CEO, Mick Mousley, CFO, Marcus Leaver, COO

Buchanan 020 7466 5000

Mark Edwards, Louise Hadcocks

About Quarto:

Quarto is one of the largest international co-edition book publishers with two principal strands of activity: its Publishing segment publishes books, under imprints owned by the Group; and its Co-Edition Publishing segment creates books that are licensed to third party publishers for publication under their own imprints in many languages around the world. 

FINANCIAL HIGHLIGHTS

Adjusted results are stated before amortization of non-current intangibles and exceptional items. The reconciliation to the statutory results appears in note 8 of this announcement.

CHAIRMAN'S REPORT

Quarto's performance exceeded expectations for the first half of 2012. This was a good achievement, given the challenging economic environment globally.

English-language book markets remain subdued, but have been adjusting to the "new normal": the shift to online retailing, the growth of e-books in the fiction and narrative non-fiction areas, and the declining shelf display space for books in big box bricks-and-mortar retail outlets. Industry commentators have noted that, thanks to lower costs for digital sales, margins are holding up, but that the volume necessary to justify investment in projects has been compromised. The decline in shelf space to display books, particularly in their natural habitat, the bookstore, is a challenge that, to date, no amount of blogging and social media have replaced.

As we have pointed in our commentaries over the years, e-books remain another delivery mechanism, another format, rather than a new medium for publishing books. As one of the world's largest publishers of illustrated books, Quarto's core business has been little affected by e-books. Illustrated titles generally don't satisfy readers' expectations when converted into e-books, and they don't make much headway; and, the erosion of display space in stores continues to diminish the audience's awareness of books that are being published.

To date, major non-English-speaking markets have yet to experience similar levels of penetration from online sales and e-books, but confidence in many European markets has been dented sharply by economic and political uncertainty. In particular, countries using the euro are growing very cautious about making commitments, given the decline in the currency's value. Unhelpfully, too, places like Brazil and Mexico have seen sharp adjustments in their currencies and this has applied the brakes to some of the growth we had hoped for this year. As the popularity of online retailing gathers pace, and e-books increase their share of the fiction and narrative non-fiction revenue, it's likely that they will follow the experience of the English-language markets.

Segmental analysis and commentary

International Co-Edition Publishing segment

The segment comprises businesses ranging in annual revenue from $1 million to approximately $17 million, reflecting different levels of maturity of the individual imprints. All of the co-edition business units license the books they create to third-party publishers around the world before they are created. No inventory is held and the businesses generate revenue from the new titles they create each year but, predominantly, from the reprints that they supply to licensees of backlist titles first published in prior years. This is a highly disciplined and low risk model, relying for its success on the integrity of each title, its relevance to the intended audience, and its ability to retain those attributes for many years and in many geographies.

The segment's strengths lie in identifying categories of enduring interest to enthusiasts into which books can be published; creating titles that inform, instruct and inspire these audiences; and taking advantage of the greater size of the global than the domestic audience to deliver a more comprehensive and useful book. This is the group's original business and Quarto's titles are published by many of the world's most established and successful publishing houses.

The first half of the year is traditionally quiet, and revenues of $19.8 million are about one-third of the anticipated annual income. Segmental revenues declined by 8%, but unevenly, with gains seen at Quintessence, producer of the 1001 series of guides to the best things in life; at QED, our children's supplementary education imprint; at Qu:id, producer of titles with a fresh look at subjects of enduring curiosity; at Global, the reference list created in Sydney; and at Fine Wine, publisher of the internationally acclaimed journal, The World of Fine Wine, and several authoritative books on major wine regions.

The decline in revenues is mainly explained by a reduction in new title output during the period. The decline in new titles is because potential licensees, in the English-speaking markets, hesitated to make forward commitments at the end of 2010, so it is not unexpected. By contrast, reprint revenues are generated as licensees require more inventory to satisfy demand.

On the whole, for the book industry, the picture is of growing stability in the English-language markets, and in Central and Eastern Europe, with increased nervousness and hesitation seen in the traditionally important major European markets, and in some emerging markets, such as Brazil and Latin America. This may be a temporary phenomenon, explained by slowing economies and currencies under pressure, but it may also continue for a while since, to date, the disruption from growth in online retailing, e-books, and declining display space for books has had a much lower impact in these geographies.

As we have explained in the past, for illustrated books of the sort that our co-edition segment produces, e-books have not made substantial inroads, not simply because the conversions from print to digital versions are unsatisfactory, but also because they aren't able to match readers' expectations of what digital content ought to provide, particularly in terms of interactivity. This mismatch is unlikely to be resolved soon, if at all, because books differ structurally from what users expect of a digital experience, being designed to be used serially, and at the pace chosen by the reader. To date, the only really successful medium to take advantage of the new platform is videogames.

The co-edition segment has good forward visibility and, in spite of anticipating continued weakness, we expect a reasonably solid performance for the year as a whole.

Book Publishing segment

Quarto's book publishing segment publishes, markets, and distributes titles under numerous imprints, primarily in the UK, the US, Australia, and New Zealand. The focus of each imprint is on its domestic market. The segment consists entirely of companies acquired by the group. All of the acquisitions have taken advantage of Quarto's co-edition experience and that has given executives in depth knowledge of readers' special interests in enduring subjects, and insights into how they go about pursuing these interests. For the first half of 2012 sales were $53.4 million. Typically, the first half represents about 40% of annual revenues.

Over the years, the segment has increasingly created how-to, instructional, and informational titles, as senior executives have shared, across the segments, their insights into special interest audiences. Management is insistent that, both in the Co-Edition and in the Publishing segments, individual units must, so far as possible, maintain focus on categories in which they can engage with their audience's interests, and must emphasize the primacy of what they create. Unlike at the large, traditional general interest publishing houses, most of the segment's imprints commission and create the major part of their lists of titles.

The primary audience for each of our publishing imprints is domestic. Our largest single market is in the United States. In the last several years, following a string of acquisitions, we have rationalized the "back office" functions of operations, finance, distribution, and accounting. In the process, many positions have been eliminated. We have also relinquished a legacy category management role at a major retailer of supplies for the smaller and hobby farmer, and we continue to refine our approach to selling. In the last few months, we have reorganized the US sales force in a regional structure as key accounts are no longer solely in the book trade, and may be located anywhere in the country.

Large challenges remain. Our new titles are available both as e-books and printed books. The relationship between printed books and e-books is now showing signs of stabilizing. The large number of backlist titles that were converted into e-books over the last 18-24 months may explain much of the increase in our digital revenues. Now, only new titles are being added.

E-books have captured almost 20% of adult title sales in the US, predominantly in the high profile, bestselling fiction and narrative non-fiction categories, where the percentage is obviously much higher. Following the loss of much of the volume print sales in these categories to aggressive online competition, principally from extremely efficient Amazon.com, this growth has been a further blow to bricks-and-mortar booksellers. Amazon is a powerful and effective competitor, a pioneer in e-book retailing, and doesn't miss a trick.

The effect on the big box book retailers has been substantial. Borders, the second largest chain, with branches throughout the English-speaking markets, succumbed last year. Barnes & Noble has produced good e-readers to compete with Amazon's Kindles, but it hasn't been able to match the single-minded focus of the latter, perhaps because of its strong physical presence, with stores across the country, and its attempts to counter the decline of its sales of volume titles with acres of non-book merchandise.

Quarto's publishing imprints in the US, with their focus on special interest categories, have pursued their audience to other big box and specialty retailers that also sell books. While some of these outlets are significant sources of volume sales, such retailers tend to be not at all dependent on book sales, and turn to wholesalers and category managers for their needs. In addition, many big box specialty retailers are themselves under pressure from online retailing in the way the chain booksellers were half a dozen years ago. For example, several years ago there were two national chains of electronic retailers, Circuit City and Best Buy. Circuit City collapsed into bankruptcy and now, faced by serious online competition, Best Buy is in turmoil, shuttering some stores and downsizing others.

Considerable challenges remain and they are chiefly in the area of display and discoverability. When we get books in front of consumers, sales follow. Online is good, but it isn't the answer, and nor is online chatter, as others and we have discovered. To date, the bookstore remains the unique place to display numerous new and backlist titles to a committed audience.

In the last decade, we made two substantial but ill-timed acquisitions of book publishing businesses. The first was of an ailing business, Creative Publishing international, publisher of extremely good home improvement titles for the keen and ambitious DIY-er. Notable chiefly for their unbeatably clear how-to explanations, the books are core titles in all the appropriate areas, such as wiring, plumbing, decking, masonry, interior carpentry, and garden work. Starting in 2006-7 the US housing market started to implode, beginning at the subprime level, but extending ever more widely in following years. As the impact blew up into a general global financial crisis and a big recession, it hit the home improvement market very severely.

Ambitious DIY-ers were not simply improving their homes for personal enjoyment; they saw their sweaty labor as a means of building equity in what seemed an unstoppable increase in the value of their homes. With home prices subsequently declining by up to 40-50% since the peak, jobs drying up, and foreclosures soaring, reality took over. Enthusiasm was displaced by despair. As most of CPi's sales took place at home improvement retailers, rather than in the bookstore, adjustment to the new reality has been harsh. We have decided to maintain the business at a lower level, one that we consider sustainable, as the housing market stabilizes, not least because several of CPi's key competitors have abandoned the effort.

The other poorly-timed acquisition, just as the storm was about to be unleashed in 2007, was of MBI Publishing Company, then perhaps the largest US publisher in the general transportation category. Unfortunately, the recession that followed the housing bust, and the credit crunch, severely affected the automobile industry, with Ford remaining the only one of the big three US automobile manufacturers to emerge intact from the storm. Of course, the audience for DIY automotive performance-improvement books dwindled, with the result that booksellers axed display space for the titles. MBI has now stabilized, albeit at a lower level.

Rockport's Quarry list, publishing into the upper end of the arts and craft market, has been a notable success, as has Walter Foster, America's longest established publisher of art instruction titles, celebrating its 90th anniversary this year. Walter Foster is doing extremely well, particularly since the back office functions were centralized, and it remains focused on its new title output.

In Australia and New Zealand, the segment operates two successful book display marketing businesses that sell books at peoples' places of work. We have devoted considerable efforts to improving these businesses' operational performances. In particular, Lifetime, based in Sydney, since we bought it in November 2004, when it was close to insolvent, has been transformed organizationally, operationally, and in management. Premier Books, in Auckland, was successful when acquired, and we have upgraded its reporting by rolling out a program of equipping distributors with handheld devices that transmit revenue and inventory information in real time, and allow management to tweak the business much more swiftly. Although the business structures are quite different, we intend to extend the handhelds to Lifetime.

In the UK, the acquisition of Frances Lincoln last August has been of great benefit. It has increased our revenues, allowing us to rationalize and centralize some of our back office functions. The process is not yet complete, as we have not yet moved the Aurum group and Frances Lincoln into the same premises. With our larger scale, we are improving our marketing and sales efforts. All imprints are performing well.

Our marketing support unit, the Image Factory, services and supplies the retail and the manufacturing sectors. After suffering a sharp downturn in the last couple of years, it is now improving steadily. Turnover remains stable, but improving margins and reduced overheads are returning it to profitability.

Against the background of the challenges, particularly at the retail level, it's worth commenting that, in all of the English-language markets, the performance of independent book retailers has held up well, in some cases defying expectations that aggressive competition from online retailing of print and e-books would further erode their viability. Demonstrating that the core audience of keen book buyers remains substantial, independent retailers have been engaging more energetically with their customers, hosting events of interest, and become more important to their local communities.

Financial

Quarto's syndicated loan agreement was successfully refinanced earlier this year, as noted in our 2011 annual report. We remain well funded. Net debt has been on the downward path, but the higher margin over Libor on our new facility means that interest costs will not immediately follow in tandem. Hedging arrangements were entered into several years ago, in pursuance of the board's aim to cap interest rates and reduce risk. In the prevailing low interest rate environment, this strategy has worked to our disadvantage.

Net debt has fallen by $2.5 million, after the outlay of $6.9 million in cash for Frances Lincoln, and highlights the cash generative aspects of the business. Close control over inventory, pre-publication costs, and collection of accounts receivable, have all improved our net position. This attention will not waver as we continue to reduce debt.

As usual, we include with this announcement a report on the Trailing Twelve Months ended June 30th, 2012, so that investors can chart Quarto's progress.

Corporate

The board has implemented a well thought out succession plan to my roles as both chairman and chief executive officer, as explained in the 2011 Annual Report.

Marcus Leaver has joined Quarto as Chief Operating Officer. Marcus is an experienced manager of publishing businesses and satisfies the board's requirement that we find a candidate well versed in book publishing internationally. He has worked as a senior publishing executive in both London and New York, coming to us from his last position as President of Barnes & Noble's publishing imprint, Sterling Publishing. Prior to that he was responsible for Chrysalis's book publishing operations in London, having done a previous stint as Corporate Development Director at Chrysalis. Marcus is admirably equipped for the task, and has returned to London, with his family, after 7 years in New York. With so much of Quarto's publishing business in the United States, we are fortunate to have access to his very current knowledge of the trade.

Marcus's familiarity with co-edition book publishing is more limited, but in his previous roles he has met all the significant players in the field in his capacity as a potential licensee. Quarto remains the most successful co-edition book publisher, is well-run, with strong teams, and it is important that Marcus becomes thoroughly familiar with the processes for deciding upon and making books in Quarto's Co-Edition segment. This will take the best part of a full cycle, culminating around the time of the Annual Meeting next year.

Two shareholders, acting at the request of Harwood Capital LLP, the investment manager of the shares held by these shareholders, have requisitioned a Special Meeting to vote on two resolutions. The resolutions are (i) to remove me as a director of the company, and (ii) to elect Mr Tim Chadwick as a director. Harwood's managing partner is the activist investor, Mr Christopher Mills.

The board, announcing the requisition on July 13th, rejected the Mills proposals. The Nominations Committee of the board is awaiting further information from Mr Chadwick about his background and qualifications. We know that Mr Chadwick was in the book publishing business many years ago, but understand that he has not been involved in the industry since it began to be transformed by the advent of Amazon and the era of e-books.

When we have enough to communicate to shareholders, we shall schedule the Special Meeting and comment on the resolutions more fully.

Prospects

Times remain tough and challenging. The pace of change has been swift and unyielding, but we are encouraged by general confidence in the printed book. Serious questions still remain as to how to reach interested audiences in an affordable way. The book-publishing ecosystem has been sundered, creating challenges and opportunities that many other sectors and infrastructures have also faced. The way forward is not clear, nor is it likely to be direct, but trial and error will uncover many new opportunities, and Quarto remains skeptical of jumping onto trendy bandwagons.

Personally, I am not a fan of budgeting and forecasting, not just at this time, but also in general. I have never been able to persuade myself that executives are endowed with prophetic insight, and am ever more mindful that most forecasting and budgeting is refined by people who look backwards for trends, rather than forwards for inspiration.

At Quarto, we know that this is already a difficult year and, in the short term, is likely to remain that way. On the plus side, a really significant part of our revenue is still to come in the second half of the year, and is derived from reprinting successful titles that the group has nourished. In recognition of the cloudy outlook, the board has declared an unchanged dividend of 3.35p per share for the first half of 2012, payable on October 26, 2012 to shareholders of record on September 28, 2012.

Laurence F Orbach

Chairman and Chief Executive Officer

August 16, 2012

THE QUARTO GROUP, INC

CONDENSED CONSOLIDATED INCOME STATEMENT

for the six months to June 30, 2012

THE QUARTO GROUP, INC

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

for the six months to June 30, 2012

THE QUARTO GROUP, INC

CONSOLIDATED BALANCE SHEET

at June 30, 2012

THE QUARTO GROUP, INC

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

for the six months to June 30, 2012

THE QUARTO GROUP, INC

CONDENSED CASH FLOW STATEMENT

for the six months to June 30, 2012

THE QUARTO GROUP, INC

NOTES TO THE INTERIM FINANCIAL STATEMENTS

for the six months to June 30, 2012

1. Introduction

These interim consolidated financial statements are for the half year to June 30, 2012. They were approved by the Board on August 16, 2012 and are unaudited, as is the case with the comparative figures to June 30, 2011. These interim financial results do not comprise statutory accounts within the meaning of Section 434 of the Companies Act 2006. Statutory accounts for the year to December 31, 2011, prepared in accordance with International Financial Reporting Standards as adopted by the EU, which carried an unmodified Auditors' Report, have been filed with the Registrar of Companies and did not contain a statement under Section 498(2) or (3) of the Companies Act 2006.

2. Basis of preparation

These interim financial statements have been prepared in accordance with the Disclosure and Transparency Rules of the Financial Services Authority and with IAS 34, "Interim Financial Reporting", as adopted by the European Union.

The Directors have formed a judgement that there is a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason, the Directors continue to adopt the going concern basis in preparing the financial statements. The Group has significant banking facilities. In particular, the Group has committed facilities of $145m through to December 6, 2012 and thereafter, $128m through to December 6, 2013. The Group has continued to comply with its bank covenants and is budgeted to do so for the foreseeable future.

The accounting policies adopted are consistent with those of the annual financial statements for the year ended December 31, 2011, as described in those financial statements.

3. Segmental analysis

4. Exceptional items

Exceptional items primarily relate to restructuring costs.

5. Taxation

Taxation for the six months to June 30, 2012 is based on the estimated effective tax rate for the year. The rate that has been used is 24.4% (June 30, 2011: 25.0% and December 31, 2011: 21.5%).

6. Earnings per share

The calculation of earnings per share is based on 19,684,191 shares (the weighted average number of issued shares, excluding those held as treasury stock) (June 30, 2011: 19,679,229 shares; December 31, 2011: 19,679,229) and profits of $94,000 (June 30, 2011: $124,000; December 31, 2011: profits of $7,648,000). The calculation of adjusted earnings per share is based on earnings of $825,000 (June 30, 2011 $859,000; December 31, 2011: $8,983,000), calculated as follows:

There is no dilution in earnings per share or adjusted earnings per share for the six months to June 30, 2012 and June 30, 2011. For the year to December 31, 2011, diluted earnings per share were 38.8c and diluted adjusted earnings per share were 45.6c.

7. Dividend

The interim dividend of 3.35p per share is payable on October 26, 2012, to shareholders on the register on September 28, 2012, with an ex-dividend date of September 26, 2012.

8. Reconciliation of figures included in the Announcement

9. Net debt

Total borrowing facilities, at June 30, 2012, were $148m. Committed facilities total $145m and comprise a $95m syndicated facility which extends to April 30, 2015, and a $50m private placement facility, which extends to December 7, 2014, on which repayment commences on December 7, 2012.

10. Risks and uncertainties

The principal risks and uncertainties affecting the business activities of the Group remain those detailed in the Annual Report for 31 December 2011, a copy of which is available on the Group website at www.quarto.com. The Board considers that these remain a current reflection of the risk and uncertainties facing the business for the second half of the financial year.

11. Directors' Responsibility Statement in respect of the Condensed Interim Financial Statements

The directors confirm that this condensed set of financial statements has been prepared in accordance with IAS 34 "Interim Financial Reporting" as adopted by the European Union, and that the interim management report includes a fair review of the information required by Disclosure and Transparency Rules of the Financial Services Authority, paragraphs DTR 4.2.7 and DTR 4.2.8.

The directors of The Quarto Group, Inc. are listed in The Quarto Group, Inc. Annual Report for 31 December, 2011. A list of current directors is maintained on the Quarto website: www.quarto.com.

THE QUARTO GROUP, INC

MANAGEMENT'S PRO FORMA ABBREVIATED INCOME STATEMENT

for the twelve months to June 30, 2012

Note:

The above figures do not include amortization of non-current intangible assets or exceptional items