UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 

 
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2000March 31, 2001
 
OR
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 1-4694
 
R. R. DONNELLEY & SONS COMPANY
(Exact name of registrant as specified in its charter)
 
Delaware
36-1004130
(State or other jurisdiction of
incorporation or organization)
36-1004130
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
77 West Wacker Drive,
Chicago, Illinois
77 West Wacker Drive,
Chicago, Illinois
60601
(Address of principal executive offices)
60601
(Zip Code)
 
Registrant’s Telephone Number (312) 326-8000
 
        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 the filing requirements for the past 90 days.
 
 ü
Yes __________
üNo__________
Yes

No

 
Number of shares of common stock outstanding
as of October 31, 2000April 30, 2001
122,041,376117,384,052
 


PART I
 
FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
Index
    Page
Number(s)

                        Condensed Consolidated Statements of Income (Unaudited) for the
                             Three and Nine Months Ended September 30,March 31, 2001 and 2000 and 1999
    3
 
                        Condensed Consolidated Balance Sheets as of September 30, 2000March 31, 2001
                             (Unaudited) and December 31, 19992000
    4
 
                        Condensed Consolidated Statements of Cash Flows (Unaudited) for
                             the NineThree Months Ended September 30,March 31, 2001 and 2000 and 1999
    5
 
                        Notes to Condensed Consolidated Financial Statements
                             (Unaudited)
    6 - 1011
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
                        Comparison of Third Quarter and First Nine Months of 2000 to
1999Company Overview
    1112 - 1715
 
Results of Operations—First Quarter 2001 to First Quarter 200015 - 18
                        Changes in Financial Condition    1718 - 1819
 
Year 2000 and System Infrastructure18
                        Other Information    19 - 2122
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk    2122
 
PART II
 
OTHER INFORMATION
 
Item 1. Legal Proceedings    2223
 
Item 4. Submission of Matters to a Vote of Security Holders23
Item 5. Other Information    2223
 
Item 6. Exhibits and Reports on Form 8-K    2223
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 

 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
(Thousands of dollars, except per-shareper share data)
 
    Three Months Ended
September 30

    Nine Months Ended
September 30

    Three Months Ended
March 31

    2000
    1999
    2000
    1999
    2001
    2000
Net sales    $1,433,000     $1,399,400     $4,164,775     $3,878,287     $1,302,650     $1,342,970 
Cost of sales    1,126,484     1,077,745     3,347,607     3,054,447     1,103,277     1,103,535 
  
  
  
  
    
  
  
Gross profit    306,516     321,655     817,168     823,840     199,373     239,435 
Selling and administrative expenses    149,591     163,965     452,456     471,671     137,781     144,294 
Restructuring and impairment charges    21,742     —  
  
  
  
  
    
  
  
Earnings from operations    156,925     157,690     364,712     352,169     39,850     95,141 
Other income (expense):                        
Interest expense    (22,810)    (23,084)    (69,912)    (66,705)    (17,624)    (22,141)
Other, net    15,980     4,559     22,841     15,447     1,359     2,937 
  
  
  
  
    
  
  
Earnings from continuing operations before income
taxes
    150,095     139,165     317,641     300,911 
Income taxes    57,787     53,578     122,292     115,851 
  
  
  
  
  
Income from continuing operations    92,308     85,587     195,349     185,060 
Loss from discontinued operations, net of income
taxes
    —      —      —      (3,007)
Earnings before income taxes    23,585     75,937 
Provision for income taxes    9,080     29,236 
  
  
  
  
    
  
  
Net income    $      92,308     $      85,587     $    195,349     $    182,053     $      14,505     $      46,701 
  
  
  
  
    
  
  
Income from continuing operations per share of
common stock
                
Basic    $          0.76     $          0.67     $          1.60     $          1.42 
Diluted    0.75     0.67     1.59     1.41 
Loss from discontinued operations per share of
common stock
                
Basic    $          —      $          —      $          —      $        (0.02)
Diluted    —      —      —      (0.02)
Net income per share of common stock                        
Basic    $          0.76     $          0.67     $          1.60     $          1.40     $          0.12     $          0.38 
Diluted    0.75     0.67     1.59     1.39     0.12     0.38 
 
See accompanying Notes to Condensed Consolidated Financial Statements.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 

 
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
September 30, 2000March 31, 2001 and December 31, 19992000
(Thousands of dollars, except share data)
 
ASSETSASSETSASSETS
    2000
    1999
    2001
    2000
Cash and equivalents    $      48,792     $      41,873     $      54,814     $      60,873 
Receivables, less allowance for doubtful accounts of $18,744 in 2000 and
$15,461 in 1999
    926,431     865,305 
Receivables, less allowance for doubtful accounts of $18,011 in 2001 and
$20,016 in 2000
    778,630     882,486 
Inventories    220,951     194,312     190,034     188,745 
Prepaid expenses    68,838     51,781     138,219     74,345 
Refundable income taxes    —      76,579 
  
  
    
  
  
Total current assets    1,265,012     1,229,850     1,161,697     1,206,449 
  
  
    
  
  
Net property, plant and equipment, at cost, less accumulated depreciation of
$2,993,549 in 2000 and $2,822,737 in 1999
    1,642,817     1,710,669 
Goodwill and other intangibles, net of accumulated amortization
of $250,322 in 2000 and $217,616 in 1999
    537,253     397,983 
Net property, plant and equipment, at cost, less accumulated depreciation of
$3,101,812 in 2001 and $3,040,871 in 2000
    1,559,528     1,620,592 
Goodwill and other intangibles, net of accumulated amortization
of $275,009 in 2001 and $266,014 in 2000
    505,256     520,242 
Other noncurrent assets    556,121     514,962     567,443     566,919 
  
  
    
  
  
Total assets    $4,001,203     $3,853,464     $3,793,924     $3,914,202 
  
  
  
  
  
  
LIABILITIES AND SHAREHOLDERS’ EQUITYLIABILITIES AND SHAREHOLDERS’ EQUITYLIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable    $    323,991     $    334,389     $    303,420     $    387,495 
Accrued compensation    179,369     175,590     145,028     184,668 
Short-term debt    391,957     419,555     449,027     271,640 
Current and deferred income taxes    65,823     10,894     20,205     43,484 
Other accrued liabilities    357,826     263,035     283,014     303,274 
  
  
    
  
  
Total current liabilities    1,318,966     1,203,463     1,200,694     1,190,561 
  
  
    
  
  
Long-term debt    753,093     748,498     750,024     739,190 
Deferred income taxes    255,813     252,884     234,283     233,505 
Other noncurrent liabilities    478,523     510,361     506,921     518,398 
  
  
    
  
  
Total noncurrent liabilities    1,487,429     1,511,743     1,491,228     1,491,093 
  
  
    
  
  
Shareholders’ equity:                
Common stock at stated value ($1.25 par value)                 
Authorized shares: 500,000,000; Issued 140,889,050 in 2000 and 1999    308,462     308,462 
Authorized shares: 500,000,000; Issued 140,889,050 in 2001 and 2000    308,462     308,462 
Retained earnings    1,599,409     1,521,474     1,622,067     1,666,936 
Accumulated other comprehensive income    (75,805)    (64,154)
Accumulated other comprehensive loss    (82,906)    (74,126)
Unearned compensation    (7,397)    (6,222)    (5,464)    (6,752)
Reacquired common stock, at cost    (629,861)    (621,302)    (740,157)    (661,972)
  
  
    
  
  
Total shareholders’ equity    1,194,808     1,138,258     1,102,002     1,232,548 
  
  
    
  
  
Total liabilities and shareholders’ equity    $4,001,203     $3,853,464     $3,793,924     $3,914,202 
  
  
    
  
  
 
See accompanying Notes to Condensed Consolidated Financial Statements.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
For the NineThree Months Ended September 30March 31
(Thousands of dollars)
 
    2000
    1999
    2001
    2000
Cash flows provided by (used for) operating activities:            
Net income    $ 195,349     $ 182,053     $   14,505     $   46,701 
Loss from discontinued operations, net of tax    —      3,007 
Restructuring and impairment charges    21,742     —  
Depreciation    242,686     242,358     81,702     80,509 
Amortization    44,085     36,158     16,210     14,378 
Gain on sale of assets    (5,871)    (4,794)    —      (4,976)
Net change in operating working capital    (93,544)    (72,205)     (123,442)    (85,287)
Net change in other assets and liabilities    121,263     (224)    (30,248)    8,074 
Other    1,538     12,649     (5,212)    (3,552)
  
  
    
  
  
Net Cash Provided by Operating Activities    505,506     399,002 
Net cash provided by (used for) operating activities    (24,743)    55,847 
  
  
    
  
  
Cash flows provided by (used for) investing activities:                  
Capital expenditures    (181,151)    (198,267)    (32,546)    (56,101)
Other investments including acquisitions, net of cash acquired    (220,679)    (170,394)    (326)     (207,343)
Dispositions of assets including investments, net of cash    22,289     5,630     —      5,222 
  
  
    
  
  
Net Cash Used for Investing Activities    (379,541)    (363,031)
Net cash used for investing activities    (32,872)    (258,222)
  
  
    
  
  
Cash flows provided by (used for) financing activities:                  
Net (decrease) increase in borrowings    (17,014)     299,216 
Net increase in borrowings    186,009     256,042 
Issuances of common stock    5,687     15,196     6,715     860 
Acquisition of common stock    (22,573)    (265,154)    (114,205)    (21,361)
Cash dividends paid    (87,058)    (83,429)    (27,640)    (26,926)
  
  
    
  
  
Net Cash Used for Financing Activities    (120,958)    (34,171)
Net cash provided by financing activities    50,879     208,615 
  
  
    
  
  
Effect of exchange rate changes on cash and equivalents    1,912     (1,353)
Net Change in Cash and Equivalents    6,919     447 
Cash and Equivalents at Beginning of Period    41,873     66,226 
Effect of exchange rate fluctuations on cash balances    677     157 
Net change in cash and equivalents    (6,059)    6,397 
Cash and equivalents at beginning of period    60,873     41,873 
  
  
    
  
  
Cash and Equivalents at End of Period    $    48,792     $    66,673 
Cash and equivalents at end of period    $    54,814     $    48,270 
  
  
    
  
  
 
See accompanying Notes to Condensed Consolidated Financial Statements.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 

 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
        NOTE 1.The condensed consolidated financial statements included herein are unaudited (although the balance sheet at December 31, 19992000 is condensed from the audited balance sheet at that date) and have been prepared by the company to conform with the requirements applicable to this quarterly report on Form 10-Q. Certain information and disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been omitted as permitted by such requirements. However, the company believes that the disclosures made are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in the company’s 19992000 Annual Report on Form 10-K.
 
        The condensed consolidated financial statements included herein reflect, in the opinion of the company, all adjustments (which include only normal, recurring adjustments) necessary to present fairly the financial information for such periods. Certain prior year amounts have been reclassified to maintain comparability with current year classifications.
 
        NOTE 2.Components of the company’s inventories at September 30, 2000,March 31, 2001, and December 31, 1999,2000, were as follows:
 
    (Thousands of
Dollars)

    2000
    1999
Thousands of dollars
    2001
    2000
Raw materials and manufacturing supplies    $128,549     $125,014     $118,914     $131,803 
Work in process    202,689     150,992     154,837     144,927 
Finished goods    2,446     1,388     1,460     2,069 
Progress billings    (65,000)    (39,901)    (33,073)    (39,450)
LIFO reserve    (47,733)    (43,181)    (52,104)    (50,604)
  
  
    
  
  
Total    $220,951     $194,312     $190,034     $188,745 
  
  
    
  
  
NOTE 3. The following provides supplemental cash flow information: NOTE 3. The following provides supplemental cash flow information:  NOTE 3.The following provides supplemental cash flow information:
    (Thousands of
Dollars)

    Nine Months Ended
September 30

    Three Months Ended
March 31

    2000
    1999
Thousands of dollars
    2001
    2000
Interest paid    $  57,536     $  44,194     $    9,425     $    8,077 
Income taxes paid    $  59,652     $  61,459     $  65,386     $  16,367 
 
        NOTE 4.On November 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Illinois, on behalf of all current and former African-American employees, alleging that the company racially discriminated against them in violation of the Civil Rights Act of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.). The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seeksought nationwide class certification, most of the specific factual assertions of the complaint relate to the closing by the company of its Chicago catalog operations in 1993. Other general claims relate to other company locations.
        On August 10, 1999,June 30, 1998, a class action was filed against the company in federal district court judge deniedin Chicago on behalf of current and former African-American employees, alleging that the company’s motioncompany racially discriminated against them in violation of Title VII of the Civil Rights Act of 1964 (Adams, et al. v. R.R. Donnelley & Sons Co.). While making many of the same general discrimination claims contained in theJonescomplaint, theAdamsplaintiffs are also claiming retaliation by the company for partial summary judgment on the basisfiling of timeliness.discrimination charges or otherwise complaining of race discrimination. The complaint seeks the same relief and damages as sought in theJonescase.
 
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—STATEMENTS (UNAUDITED)—(Continued)
        On April 6, 2001, in an amended opinion, the district court judge in theJonesandAdamscases certified three plaintiff classes in the actions: a class consisting of African-American employees discharged in connection with the shutdown of the Chicago catalog operations; a class consisting of African-American employees of the Chicago catalog operations after November 1992 who were other than permanent employees; and a class consisting of African-Americans subjected to an allegedly hostile working environment at the Chicago catalog operations, the Chicago Financial, Pontiac or Dwight, Illinois, manufacturing operations. The judge also consolidated theJonesandAdamscases for pretrial purposes. On May 1, 2001, the federal court of appeals denied plantiffs’ application for leave to appeal the certification of classes.
 
        On December 18, 1995, a class action was filed against the company in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. On August 14, 1997, the court certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations.
 
        On June 30, 1998,December 28, 2000, a purported class action was filedbrought against the company and certain of its benefit plans in federal district court in Chicago on behalf of current andcertain former African-American employees alleging that the company racially discriminated against them in violation of Title VII of the Civil Rights Act of 1964 Chicago catalog operations(Adams,Jefferson, et al. v. R.R. Donnelley & Sons Co., et al.)). While making many of the same general discrimination claims contained in theJonescomplaint, theAdamsThe suit alleges that enhanced pension benefits were not paid to plaintiffs and that plaintiffs are also claiming retaliation bybeing required to contribute to the company for the filingcosts of discrimination charges or otherwise complainingretiree medical coverage, both in violation of race discrimination.plan documents and ERISA. The complaint seeks recalculation of pension benefits due plaintiffs since their retirement dates, reimbursement of any amounts paid by plaintiffs for medical coverage, interest on the same relief and damagesforegoing amounts, as soughtwell as a declaration as to the benefits due plaintiffs in theJonescase. future.
 
        Both theTheJones, GerlibandGerlibJeffersoncases relate primarily to the circumstances surrounding the closing of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations.operations, and that certain claims of the classes of former employees of the Chicago catalog operations are untimely. On December 20, 2000, in theJonescase the company filed a renewed motion for partial summary judgment on the basis of timeliness, which is pending. Further, with regard to all three cases, the company believes it has a number of valid defenses to all of the claims made and will vigorously defend its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of any of the pending cases.
 
        In December 1999, the U.S. Environmental Protection Agency, Region 5 (U.S. EPA) issued a Notice of Violation against the company, pursuant to Section 113 of the Clean Air Act (the Act). The notice alleges that the company’s facility in Willard, Ohio, violated the Act and Ohio’s State Implementation Plan in installing and operating certain equipment without appropriate air permits. While the notice does not specify the remedy sought, upon final determination of a violation, the U.S. EPA may issue an administrative order requiring the installation of air pollution control equipment, assess penalties, or commence civil or criminal action against the company. The company responded to U.S. EPA on March 10, 2000. The company does not believebelieves that any unfavorable resultthe resolution of this proceedingmatter, even if unfavorable to the company, will have a materialnot materially impact on the company’sits financial position or results of operations.
 
        In addition, the company is a party to certain litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the operations or financial condition of the company.
 
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
NOTE 5.Under Statement of Financial Accounting Standards (SFAS) No. 130,Reporting Comprehensive Income,the company reports changes in shareholders’ equity that result from either recognized transactions or other economic events, excluding capital stock transactions, which impactaffect shareholders’ equity. For the company, the only differencedifferences between net income and comprehensive income was the effect of the change in unrealized foreign currency translation losseswere as follows:
 
     (Thousands of Dollars)
    (Thousands of Dollars)
     Three Months Ended
September 30

    Nine Months Ended
September 30

     2000
    1999
    2000
    1999
Net income    $92,308     $85,587     $195,349     $182,053 
Unrealized foreign currency loss     (5,796)    (4,230)    (11,651)    (12,364)
      
      
      
      
  
Comprehensive income    $86,512     $81,357     $183,698     $169,689 
      
      
      
      
  
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
     Three Months Ended
March 31

Thousands of dollars
    2001
    2000
Net income    $14,505     $46,701
Net losses on cash flow hedging activities    (6)    
Unrealized foreign currency gain (loss)    (8,774)    4,973
      
      
Comprehensive income    $  5,725     $51,674
      
      
 
        NOTE 6.The company operates primarily withinin the commercial print portion of the printing industry, with related service offerings designed to offer customers complete solutions for communicating their messages to target audiences. Substantially all revenues within commercial printing result from the sale of printed products and services to customers in the following end-markets: Long-RunLong-run Magazines, Catalogs and Inserts; Telecommunications; Book Publishing Services; Financial Services; Telecommunications; Short-Run Magazines and Catalogs (served by our Specialized Publishing Services operation);Services; RRD Direct; Premedia; and International, which provides similar products and services outside the United States. The company’s Premedia services, which include capturing content, converting it to the appropriate format and channeling it to multiple communications media, are included within themanagement has aggregated its commercial print businesses as one reportable segment “Commercial Print.”because of strong similarities in the economic characteristics, nature of products and services, production processes, classes of customers and distribution methods used.
 
        R.R. Donnelley Logistics Services (Donnelley Logistics) represents the company’s logistics and distribution services operation for its print customers and other mailers. Donnelley Logistics serves its customers by consolidating and delivering printed product and parcelspackages to the U.S. Postal Service closer to the final destination, thereby resulting in reduced postage costs and improved delivery performance. Following the company’s acquisition of certain net assets of CTC Distribution Services LLCL.L.C. (CTC) in February 2000, the combined operations of Donnelley Logistics and CTC have been included within the reportable segment “Logistics Services” for the three and nine months ended September 30, 2000. Prior year amounts have been restated to reflect the current year presentation.Services.” Refer to Note 9 to the condensed consolidated financial statements for additional informationmore details regarding the acquisition of CTC.
        In connection with the acquisition of CTC, the company has changed its presentation of reported operating results for Donnelley Logistics. Previously, net sales of Donnelley Logistics were classified net of transportation costs. For the three and nine months ended September 30, 2000, the company reported net sales for Logistics Services on a gross basis, without deducting transportation costs. Cost of sales for Logistics Services now includes the cost of transportation. The effect of this change for the three and nine months ended September 30, 1999, was to increase both net sales and cost of sales by $59 million and $163 million, respectively; there was no impact on gross profit or earnings (loss) from operations.
        For the three and nine months ended September 30, 2000, Logistics Services’ operating results include net sales from CTC of $84 million and $234 million, respectively.
 
        The company has disclosed earnings (loss) from operations as the primary measure of segment earnings (loss). This is the measure of profitability used by the company’s chief operating decision-maker that is most consistent with the presentation of profitability reported within the consolidated financial statements. The accounting policies of the business segments reported are the same as those described in the “Summary of Significant Accounting Policies” (F-6footnote on page F-6 in the 19992000 Annual Report on Form 10-K).10-K.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—STATEMENTS (UNAUDITED)—(Continued)
 
 
Industry Segment Information
 
In Thousands
  Commercial
Print

  Logistics
Services

  Other (1)
  Corporate
  Discontinued
Operations (2)

  Consolidated
Total

Third Quarter Ended
     September 30, 2000
            
Net sales  $1,265,416  $164,593   $    2,991   $    —    $   —   $1,433,000
Earnings (loss) from operations  164,001  (2,857)  (10,722)  6,503   —   156,925
Earnings (loss) from continuing
     operations before income taxes
  171,401  (2,882)  (13,269)  (5,155)  —   150,095
 
Third Quarter Ended
     September 30, 1999
            
Net sales  $1,265,489  $  72,472   $  61,439   $        —    $      —   $1,399,400
Earnings (loss) from operations  152,672  3,359   (393)  2,052   —   157,690
Earnings (loss) from continuing
     operations before income taxes
  156,605  3,321   (621)  (20,140)  —   139,165
 
Nine Months Ended
     September 30, 2000
            
Net Sales  $3,680,304  $471,368   $  13,103   $        —    $      —   $4,164,775
Earnings (loss) from operations  370,289  (3,931)  (23,477)  21,831   —   364,712
Earnings (loss) from continuing
     operations before income taxes
  388,188  (4,031)  (27,038)  (39,478)  —   317,641
Assets  3,083,697  239,466   33,113   644,927   —   4,001,203
 
Nine Months Ended
     September 30, 1999
            
Net Sales  $3,500,538  $198,007   $179,742   $        —    $      —   $3,878,287
Earnings (loss) from operations  341,595  6,172   (1,572)  5,974   —   352,169
Earnings (loss) from continuing
     operations before income taxes
  353,054  6,134   (2,311)  (55,966)  —   300,911
Assets  3,181,298  50,077   101,800   605,657   40,582  3,979,414
Thousands of dollars
    Commercial
Print

    Logistics
Services

    Other(1)
    Corporate
    Consolidated
Total

First Quarter Ended March 31, 2001                    
Net sales    $1,114,030    $186,218     $  2,402     $      —      $1,302,650
Restructuring and impairment charges    19,702    —      —      2,040     21,742
Earnings (loss) from operations    35,687    (4,593)     (7,266)    16,022     39,850
Earnings (loss) from continuing operations
     before income taxes
    38,456    (4,610)    (7,337)    (2,924)    23,585
Assets    2,832,587    248,424     8,886      704,027     3,793,924
First Quarter Ended March 31, 2000                     
Net sales    $1,188,675    $149,251     $  5,044     $      —      $1,342,970
Restructuring and impairment charges    —     —      —      —      — 
Earnings (loss) from operations    94,539    (606)    (3,884)    5,092     95,141
Earnings (loss) from continuing operations
     before income taxes
    96,425    (648)    (3,838)    (16,002)    75,937
Assets    3,087,910    238,888     14,454     771,407     4,112,659

 
(1)Represents other operating segments of the company, including Red Rover Digital, Inc., the company’s wholly-owned subsidiary and formerly its Online Services division, which assists customers in the delivery of content and commerce online. 1999 also includes the results of operations and assets of Stream International (refer to “Divestitures” in Item 2).
(2)Refer to discussion of “Discontinued Operations” in Item 2, which describes the separate presentation of the net assets and results of operations of discontinued operations.Digital.
 
        NOTE 7.The company has used corporate-owned life insurance (COLI) to fund employee benefits for several years. In 1996, the United States Health Care Reform Act was passed, eliminating the deduction for interest from loans borrowed against COLI programs. 1998 was the final year of the phase-out for deductions. TheIn closing the Internal Revenue Service (IRS), in its routine audit of the company, has disallowed the $34 million of tax benefit that resulted from the COLI interest deductions claimed by the company in itscompany’s 1990 to 1992 tax returns.returns, the company paid during the first quarter of 2001 approximately $62 million in taxes and interest for COLI interest deductions disallowed by the IRS. The company accrued for this payment as a current liability at December 31, 2000. The company may file a claim for refund of this payment and ultimately pursue litigation of this matter.
 
        In twothree federal trial court decisions involving different corporate taxpayers, the courts disallowed deductions for loans against those taxpayers’ COLI programs. A trial involving a taxpayer in another court is imminent, and appealsAppeals from the first twothese decisions have been or are expected to be taken. While the company believes its COLI program differs from those involved in the earlier litigation, should the reasoning of these cases be upheld and applied to others, in addition to payments already made, the company could lose an additional maximum of $152up to $155 million in federal and state tax benefits for periods from 1993 through 1998. In addition, should all or a portion1998 plus interest of the company’s COLI deductions ultimately be disallowed, the company would be liable for interest on those amounts. The company’s maximum exposure for interest should all prior COLI deductions be disallowed is approximately $62$50 million after-tax through September 30, 2000 .March 31, 2001.
 
        The company will continue to examine its COLI position with respect to the final resolution of pending cases. During the fourth quarter of 1999, the company recorded an additional tax provision of $51 million ($0.40 per diluted share) related to COLI. The ultimate resolution of thesethe company’s COLI issues may have a material impact on the company’s results of operations and financial condition.
 
        NOTE 8.The following summarizes share information as a basis for both the basic and diluted earnings per share computation in accordance with SFAS No. 128,Earnings per Share:Share:
 

    In Thousands

    Three Months Ended
September 30

    Nine Months Ended
September 30


    2000
    1999
    2000
    1999
In thousands
    Three Months
Ended March 31

2001
    2000
Average shares outstanding—basic    121,936    127,608    122,012    130,089    119,600    122,140
Effect of dilutive securities    1,503    800    1,167    1,145    1,718    739
  
  
  
  
  
  
Average shares outstanding—diluted    123,439    128,408    123,179    131,234    121,318    122,879
  
  
  
  
  
  
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
 
        NOTE 9. OnDuring February 7, 2000, the company acquired certain net assets of CTC, one of the largest mailershippers of business-to-home parcelspackages in the United States, for approximately $161$160 million, net of cash acquired. CTC, formerly headquartered in Minneapolis, Minn.,Minnesota, has 1819 facilities nationwide. The acquisition has been accounted for using the purchase method of accounting. The purchase price has been allocated based upon estimated fair values at the date of acquisition, pending final determination of acquired balances.the acquisition. Goodwill from this transaction of approximately $150$153 million (based upon the preliminary purchase price allocation) is being amortized over a 20-year period.
 
        NOTE 10. In July 2000,On January 1, 2001, the Emerging Issues Task Force reached a final consensus on the classification of shipping and handling fees (Issue No. 00-10,“Accounting for Shipping and Handling Fees and Costs”). This consensus states that all amounts related to shipping and handling billed to a customer in a sale transaction, if any, represent revenue to the vendor and should be classified as revenue. The implementation date of this standard is fourth quarter 2000. The company does not believe that the new standard will have a material impact on the reporting of its segments.
        NOTE 11. In June 1998, the Financial Accounting Standards Board issuedadopted SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities,, which requiresas amended by SFAS No. 137 and SFAS No. 138. These standards require that all freestanding derivatives and certainmany derivatives embedded in other contracts be recognized on the balance sheet as either an asset or liability measured at fair value. Changes in the derivative instrument’s fair value will be recognized currently in earnings or in other comprehensive income if specific hedge accounting criteria are met.
        In accordance with the provisions of SFAS No. 133, the company recorded a transition adjustment upon adoption of the standard to recognize its derivative instruments at fair value, to recognize the ineffective portion of transactions accounted for as cash flow hedges at transition and to recognize the difference (attributable to the hedged risks) between the carrying values and fair values of related hedged assets and liabilities. The effect of this transition adjustment decreased reported net income in the quarter by an immaterial amount. The company also recorded an immaterial transition adjustment in Accumulated Other Comprehensive Loss to recognize previously deferred net gains on those derivatives considered cash flow hedges at transition. The company will reclassify into earnings during the next five months the transition adjustment that was recorded in Accumulated Other Comprehensive Loss as of January 1, 2001.
        The company has limited transactions that fall under the accounting rules of SFAS No. 133. From time to time the company uses financial instruments, including forward exchange and option contracts, to manage exposure to movements in exchange rates. The company currently has two foreign currency fair value hedges. There are no outstanding cash flow hedges. As of January 1, 2001, and during the interim period ended March 31, 2001, the effect of these derivative instruments as recorded in the accompanying financial statements was not material.
        The company formally documents its hedge relationships, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. Derivatives are recorded in the Condensed Consolidated Balance Sheets at fair value in other assets and other liabilities. This process includes linking derivatives that are designated as hedges of specific assets, liabilities, firm commitments or forecasted transactions. The company formally assesses both at inception and at least quarterly (atthereafter, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in either the fair value or cash flows of the hedged item. The assessment of effectiveness for option contracts is based on changes in the intrinsic value of the option due to changes in the spot exchange rate. Changes in the time value of option contracts are reported currently in earnings. When it is determined that a minimum) markedderivative ceases to be a highly effective hedge, the company discontinues hedge accounting.
NOTE 11.The company regularly assesses its manufacturing platforms to assure that they are efficient, flexible and properly aligned with customer needs. During the first quarter of 2001, the company approved various restructuring actions, primarily consolidations of operations. As a result of the restructuring plans, the company recorded a pretax charge against income from continuing operations of $22 million or $13 million after-tax ($0.11 per diluted share).
        The restructuring actions resulted in the closing of several facilities, including a directory-printing plant in St. Petersburg, Florida; a magazine-printing plant in South Daytona, Florida; and a financial- printing facility located in Houston, Texas. In addition, there have been workforce reductions at other facilities, primarily within Financial Services and Premedia. Simultaneously, in connection with the company’s transition of directory-printing operations from a plant in York, England to a newly-constructed plant in Flaxby, England, the company incurred severance costs. In total, approximately 520 positions have been eliminated during the first quarter of 2001, resulting in severance and severance-related costs of $10 million.
        Exit costs relating to facility closures total $2 million and consist primarily of costs to maintain the buildings at closed facilities until the estimated sale date. The company also has incurred restructuring-related costs that have been expensed as incurred. In the first quarter of 2001, such costs were $1 million and consisted primarily of costs to transfer equipment from closed facilities to other company facilities as well as employee relocation costs.
        At facilities that are being closed, assets being disposed of were written down to their fair market values, less estimated costs to sell. Fair market value through earningsof land, buildings and other comprehensive income. This statementsignificant pieces of equipment was based upon external appraisals. Impairment recognized in the first quarter of 2001 relating to buildings and equipment to be disposed of was $6 million. The net book value of assets to be disposed of at March 31, 2001 was $28 million.
        The company expects to complete restructuring activities initiated in the first quarter of 2001 by the end of the first quarter of 2002, with the possible exception of the sale of land and buildings. Though the properties are currently being actively marketed and production has been subsequently amendedeither ceased or is expected to cease by SFAS 137 (which moved the effective dateend of the second quarter 2001, sales may not close within one year, due to fiscal years beginning after June 15, 2000)real estate market conditions. Additional charges related to this restructuring are expected to range from $8 million to $10 million, with the majority anticipated to be recognized by the second quarter of 2001, and SFAS 138. These rules become effective forprimarily relate to equipment and employee relocation.
        During the first quarter of 2001, the company on January 1, 2001.recognized an impairment charge for $2 million to write down the carrying values of two Internet-related technology investments recorded using the cost method of accounting. Both investments related to entities that had experienced significant solvency issues during the first quarter of 2001, such that the company believed it was probable that the carrying values would not be recovered.
        The following table summarizes activity during the quarter and the restructuring reserve balance as of March 31, 2001:
Thousands of dollars
    Severance
Costs

    Exit Costs
    Asset impairment
(non-cash)

    Total
Restructuring provision    $10,242     $2,299    $ 8,216     $20,757 
Additions (expense as incurred)    985     —     —      985 
Cash payments    (3,956)    —     —      (3,956)
Non-cash items    —      —     (8,216)    (8,216)
    
    
  
    
  
Reserve balance March 31, 2001    $  7,271     $2,299    $    —      $  9,570 
NOTE 12.On April 30, 2001, the company announced it had decided to close its Des Moines, Iowa, printing facility, which produces magazines and catalogs. The company ishad announced during the first quarter of 2001 that it was considering the possibility of closing this facility. The Des Moines facility employs approximately 800 people, the majority of which are represented by collective bargaining units. The company expects to gradually transition production to other of its facilities through the first quarter of 2002. Costs related to the shutdown and subsequent sale of the facility are expected to range from $30 million to $35 million and will be recorded in the process of analyzing the impact of SFAS 133 as amended, and as of September 30, 2000, does not believe that the new standards will have a material impact on its results of operations or financial condition.subsequent periods.
 
Item 2
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Comparison of Third Quarter and First Nine Months of 2000 to 1999
About the Company Overview
 
        R.R. Donnelley & Sons Company is a leading commercial printer,(NYSE:DNY) provides comprehensive, integrated communications services that efficiently and logistics company.effectively produce, manage and deliver our customers’ content, regardless of the communications medium. While our superior print capabilities remain the foundation of the company, our recent focus on expanding our range of offerings with value-added services allows us to create additional value.
        We provide solutions designed to enhance the effectiveness of our customers’ communications. Our services include:
·
Content creation—to provide creative design services to maximize the impact of communications and improve response rates. In addition to in-house capabilities, alliances with best-in-class providers complement our service offerings.
·
Digital asset management—to help our customers leverage their content to reach end-users through multiple marketing channels. Through our premedia services, we digitally capture content, convert it to the appropriate format and channel it to multiple communications media, including print and the Internet.
·
Production—to drive results for our customers cost-effectively through print or the Internet. Our manufacturing operations around the world offer a full range of capabilities and are networked to produce quickly large printing jobs with identical specifications. We also are able to version printed content to reach targeted audiences. Our Internet services include website production to extend our customers’ brands to the Internet by delivering content and commerce online through our Red Rover Digital (Red Rover) subsidiary.
·
Distribution—to deliver our customers’ words and images efficiently and reliably through print or the Internet. R.R. Donnelley Logistics (Donnelley Logistics) delivers printed products and packages to the U.S. Postal Service (USPS), saving our customers significant time and money. Red Rover offers a full range of services to deliver value, maximize content effectiveness, enhance our clients’ businesses and build their customer relationships via the Internet.
        Our 137-year history as a printing industry leader positions us well for the future. The printing industry is projected to grow along with the communications industry. Print advertising is expected to remain among the most cost-effective ways for our customers communicate more efficientlyto deliver their messages and effectivelygenerate revenue as they use words and images to inform, educate, entertain and sell. In each of our businesses, we use our distinctive capabilitiessell to manage and distribute words and images in ways that provide the greatest value to every customer. Our common stock (NYSE: DNY) has been publicly traded since 1956. At the end of September 2000, we had approximately 34,000 employees on four continents. We offer a full range of integrated service solutions to serve our customers’ needs from over 100 manufacturing, service and logistics locations. While we have extended our core competencies into selected international markets, 89% of our revenue is currently generated in the United States.
        Printing in the United States is a large and fragmented industry that generates more than $150 billion in annual revenue. The commercial printing portion of the industry accounts for more than $80 billion in annual revenue. The commercial printing end-markets that we currently serve generate more than $40 billion in annual revenue.their audiences.
 
        We are first or second in annual revenue in all five of our primary end-markets:
Long-Run Magazines, Catalogs and Inserts—serving the consumer and business-to-business catalog, magazine and advertising markets;
Book Publishing Services—serving the consumer, religious, professional and educational book markets;
Financial Services—serving the global communication needs of the financial markets and mutual fund companies, as well as the banking, insurance and health care industries;
Telecommunications—serving the global directory needs of telecommunications providers; and
Specialized Publishing Services—serving the needs of publishers of short-run magazines and catalogs.
        We believeconfident that print is a vital component of the communications process and expect the print marketwill remain integral to grow due tosuccessful marketing given its unique capabilities, such as portability and high-quality graphics that cannot be duplicated by other communications methods. In addition, we see opportunitiesWe also believe that the nature of print will evolve. The ability of print to createbe targeted, timely, flexible and expand complementary businesses that leverage our core competencies and help our customers succeed. Our intent is to differentiate ourselves based on ourintegrated with other communications media will become more critical.
End-Market Descriptions
        We operate primarily in the commercial print portion of the printing industry, with related service offerings. Our related services,offerings designed to offer our customers complete solutions for communicating their messages to target audiences regardless of the means of distribution, include:
Premedia—capturing content, converting it to the appropriate format and channeling it to multiple communications media, including print and the Internet;
Logistics Services—more efficiently delivering parcels and printed products through a nationwide network and the U.S. Postal Service, as well as expedited delivery capabilities, saving significant amounts of time and money; and
Red Rover Digital, Inc.—helping customers effectively leverage the Internet and their established brands by delivering content and commerce online.
        Our objective is to create above-average shareholder value through our strategies to:
·
transform our core printing businesses through process variability reduction and continuous improvement;
·
speed growth in our service-oriented businesses; and
·
logically extend into complementary businesses which leverage our customer relationships and capabilities.
        The new business opportunities that we pursue will leverage our established strengths and will further our goal of managing and distributing words and images to help our customers succeed in informing, educating, entertaining and selling.
        Our established strengths include:
·
long-standing customer relationships;
·
a strong brand and reputation for quality, service and reliability;
·
standing as a trusted, neutral partner;
·
expertise in content management;
·
scale to deliver economical solutions for our customers;
·
technology to seamlessly help our customers deliver their messages through various communications channels; and
·
a diversified portfolio of businesses and platforms to meet the most demanding customer needs.
        In addition to our U.S. operations, we operate in Mexico, South America, Europe and China. For reporting purposes, revenues from our facilities in China and England serving primarily the directory and financial services markets are reported within Telecommunications and Financial Services, respectively. One of our facilities in Mexico serves the book market and is reported within Book Publishing Services. Revenue from our other two facilities in Mexico that serve primarily the magazine market, as well as revenues from our facilities in Poland and South America, which serve more than one market, are included in International. The “Other” classification within Commercial Print includes net sales from Premedia and RRD Direct, which supplies direct mail products and services.
targeted audiences. While our operationsmanufacturing plants, financial service centers and sales offices are located throughout the United States and selected international markets, the supporting technologies and knowledge base are common. Our manufacturing plantslocations have a range of production capabilities to serve our customers and end-markets,end-markets. We manufacture products with the operational goal of optimizing the efficiency of the common manufacturing and asdistribution platform. As a result, most plants produce work for customers in more than onetwo or three of our end-markets.
 
        The following describes the end-markets we serve:
Net SalesLong-run Magazines, Catalogs and Inserts    R.R. Donnelley is a leader in the North American magazine, catalog and advertising insert markets. These markets are characterized by End-Marketdemand for large, cost-effective print runs with excellent opportunity for differentiation among competitors through services such as premedia and Donnelley Logistics. Our U.S. customers include seven of the top 10 magazine titles, nine of the top 10 consumer catalog companies and eight of the top 10 retailers. Contracts typically span from three to five years.
 
Third Quarter Ended September 30
(Thousands of Dollars)

    2000
    % of Total
    1999
    % of Total
Long-Run Magazines, Catalogs and Inserts    $    471,492     32.9%    $    464,692     33.2%
Telecommunications    209,621     14.6%    212,367     15.2%
Book Publishing Services    200,799     14.0%    211,295     15.1%
Financial Services    154,245     10.8%    167,156     11.9%
International    82,603     5.8%    76,942     5.5%
Specialized Publishing Services    70,114     4.9%    52,377     3.7%
Other    76,542     5.3%    80,660     5.8%
    
    
  
    
Total Commercial Print    1,265,416     88.3%    1,265,489     90.4%
Logistics Services    164,593     11.5%    72,472     5.2%
Other    2,991     0.2%    61,439     4.4%
    
    
  
    
Total Net Sales    $1,433,000     100.0%    $1,399,400     100.0%
          
        
Cost of materials    (459,553)        (478,455)    
Cost of transportation    (133,945)        (55,461)    
    
        
      
          Total Value-Added Revenue    $    839,502         $    865,484     
    
        
      
Telecommunications    R.R. Donnelley is the worldwide leader in the directory market. We serve the global directory needs of telecommunications providers, including three of the four U.S. Regional Bell Operating Companies, independent telephone companies such as Sprint, independent directory publishers such as McCleod and Yellow Book, and leading international telecommunications providers such as British Telecom, Dutch KPN and Shanghai Telephone.
 
Nine Months Ended September 30
(Thousands of Dollars)

    2000
    % of Total
    1999
    % of Total
Long-Run Magazines, Catalogs and Inserts    $1,346,223     32.3%    $1,316,848     34.0%
Telecommunications    612,339     14.7%    612,863     15.8%
Book Publishing Services    578,354     13.9%    558,621     14.4%
Financial Services    497,157     11.9%    471,889     12.2%
International    240,073     5.8%    197,520     5.1%
Specialized Publishing Services    198,575     4.8%    147,022     3.8%
Other    207,583     5.0%    195,775     5.0%
    
    
  
    
Total Commercial Print    3,680,304     88.4%    3,500,538     90.3%
Logistics Services    471,368     11.3%    198,007     5.1%
Other    13,103     0.3%    179,742     4.6%
    
    
  
    
Total Net Sales    $4,164,775     100.0%    $3,878,287     100.0%
          
        
Cost of materials    (1,364,533)        (1,324,519)    
Cost of transportation    (381,055)        (154,343)    
    
        
      
          Total Value-Added Revenue    $2,419,187         $2,399,425     
    
        
      
        Directory contracts typically span five to 10 years, with our current major contracts expiring between 2004 and 2009. Deregulation and substantial investment in the global telecommunications industry provide growth opportunities. In addition, growth opportunities arise as we work with directory publishers to introduce innovations such as targeted printed directories, website development for small businesses, content for online directories and solutions for the technology and government markets, and as we extend our capabilities worldwide.
 
Book Publishing Services    R.R. Donnelley, the leader in the North American book market, serves the trade, children’s, religious and educational book segments. We are a key supplier for all of the top 10 U.S. book publishers and we print more than 50% ofThe New York Times’adult best-seller titles. We also print one-third of all textbooks used in classrooms in the United States.
        We are one of the leading converters of book publishers’ content to electronic format for electronic books, or e-books, providing services for all major e-book formats. We have converted approximately 1,500 titles to date, including Stephen King’s novellaRiding the Bullet,which was distributed only online.
Financial Services    R.R. Donnelley Financial, a leader in the U.S. and international financial services markets, supports the communications needs of corporations and their investment banks as they access the global capital markets. We also are a leading provider of customized communications solutions for investment management, banking, insurance, managed care and pharmaceutical companies.
        Our global service network, manufacturing platform and distribution system give us unique advantages in servicing the capital markets, particularly for large financial deals. For example, the four largest transactions of the 1990s used R.R. Donnelley Financial to communicate their deals. Additionally, we are a leading provider of mutual fund compliance communications. To meet our clients’ needs for accuracy, speed, confidentiality and convenience, we have developed technology for virtual deal management and Internet-enabled inventory management, are experts in EDGAR HTML filings and have integrated database management with content assembly, digital output and multiple-media delivery.
        Our customized communications solutions provide an integrated suite of information management, content assembly and delivery solutions designed to give our clients closer and longer-lasting relationships with their customers. In markets that increasingly see demand for more precise communication with individuals, we believe customized communications solutions are and will continue to be a significant growth opportunity for the company.
International    We have extended our core competencies for high quality print and related services into non-U.S. geographic markets with no pre-existing local solution. These markets tend to be emerging, with favorable demographic trends such as rising education levels and increasing disposable income. Our international operations in Poland, Mexico and South America, where we produce magazines, books and telephone directories, are reported as “International.” Financial Services’ international revenue is included in Financial Services. Directory revenues from China and England are included in Telecommunications.
Specialized Publishing Services    R.R. Donnelley is a leader in providing short-run publishers, catalogers and associations with comprehensive communications solutions. We serve customers with highly targeted audiences and typical production runs from 10,000 to 200,000 copies. We offer full-service and cost-effective solutions for business-to-business and consumer magazine and catalog publishers, as well as journal, association and academic publishers.
RRD Direct    R.R. Donnelley is a leader in the U.S. direct-mail market, offering expertise and a range of services to guide customers smoothly and cost-effectively through direct-marketing projects. Our full-service solutions include content creation, database management, premedia, printing, personalization, finishing and distribution. We produce highly personalized and sophisticated direct mail pieces that generate results for our customers.
Premedia    In our premedia services, we leverage digital technologies to effectively create, manage and prepare customer content and distribute it via various communications media, including print and the Internet. We have developed technology that allows customers to securely access their digital content in an Internet-enabled database and repurpose it for multiple uses. These technologies include our ImageMerchant® ASP (Application Service Provider) service for merchandisers, AdSpring™ ASP and PubSpring™ services for magazine publishers, and Photo-Flow™ for photography customers.
R.R. Donnelley Logistics    R.R. Donnelley is one of the largest users of the USPS, handling approximately 25% of the ground packages and 15% of the magazines delivered by the USPS. No other business partner of the USPS approaches our volume levels in these combined categories. Distribution costs are a significant component of our customers’ cost structures, and our ability to deliver mail and packages more predictably and cost-effectively is a key differentiator for us.
        Our February 2000 acquisition of CTC Distribution Services L.L.C. (CTC) extended our services by adding package delivery to our established business of delivering printed material (freight services). By leveraging the USPS infrastructure to make the final delivery to households and businesses, we are able to provide more economical logistics services. Through “zone skipping” we are able to obtain greater postal discounts and provide more timely, reliable delivery for our customers. As we complete the integration of CTC and further develop our processes for zone skipping, we are able to bring together our scale, systems and expertise to create logistics services that are valuable to our customers.
        In addition to delivering packages and printed material, we also provide returns management and expedited distribution of time-sensitive and secure material (expedited services). Together, these services help merchandisers and other businesses manage their supply chains more effectively and at a lower cost.
Red Rover Digital    This subsidiary (included in the operating segment “Other”) can meet our customers’ Internet needs using a range of services including a full suite of scalable communications and e-commerce solutions. Red Rover implements solutions that deliver value, maximize content effectiveness, enhance our clients’ businesses and build their customer relationships. Services such as strategy, design, editorial, development and production populate sites with content, and provide the end-to-end solutions necessary for businesses to survive on the Internet today. Our partnerships and investments in this arena strengthen our online services offering, expand our solutions and help our customers leverage the power of the Internet to communicate with their audiences.
Results of Operations—First Quarter 2001 to First Quarter 2000
Consolidated Results    Net sales decreased $40 million, or 3.0%, to $1,303 million compared with $1,343 million in the first quarter of Operations2000. Acquisitions contributed an increase of $54 million in net sales between years, which was offset by lower organic sales.
 
        For the third quarter, net income from continuing operations was $92 million in 2000, or $0.75 per diluted share, compared with $86 million in 1999, or $0.67 per diluted share. Third quarter 2000 results included a one-time non-operating pretax gain of $13 million ($8 million after-tax, or $0.06 per diluted share) related to the sale of shares received from the demutualization of our basic life insurance carrier. Excluding the effect of this one-time gain, earnings per diluted share from continuing operations for the third quarter of 2000 were $0.69, up 3% from a year ago, reflecting lower average shares outstanding. Earnings per diluted share from continuing operations of $0.67 in the third quarter of 1999 included a $0.01 favorable impact from Stream International (Stream) (refer to “Divestitures”).
        Earnings from operations fell $1 million, or less than 1%, to $157 million in the third quarter of 2000 from the prior year third quarter. Excluding the impact of Stream in 1999, earnings from operations were up 1% in the third quarter of 2000 from a year ago. This third quarter increase was driven primarily by the strength of our Long-Run Magazines, Catalogs and Inserts operations, including higher by-product sales, and reduced expenses related to Year 2000. These results were mostly offset during the third quarter of 2000 by a slowdown in the domestic Capital Markets which negatively affected Financial Services, volume shortfalls at RRD Direct, operating issues within the Logistics Services segment, additional growth-related expenditures and investments in new systems. The operating issues within the Logistics Services segment included lower than expected parcel volume at CTC, unfavorable work mix at Donnelley Logistics, and recognition of approximately $1.6 million in additional costs to address start-up issues at its Northeast Consolidation Center.
        For the first nine months, net income from continuing operations was $195 million in 2000, or $1.59 per diluted share, including the $0.06 one-time demutualization gain noted above, compared with $185 million in 1999, or $1.41 per diluted share. Excluding the one-time demutualization gain, the 9% increase in earnings per diluted share from continuing operations for the first nine months reflected lower average shares outstanding, as well as an increase in earnings from operations discussed below. Earnings per diluted share from continuing operations of $1.41 in the first nine months of 1999 included a $0.02 favorable impact from Stream. The effective tax rate throughout the first nine months of both years was 38.5%.
        Earnings from operations rose $13 million, or 4%, to $365 million during the first nine months of 2000 from the same period a year ago. This increase was driven primarily by the strength of our Long-Run Magazines, Catalogs and Inserts and Book Publishing Services’ operations, including higher by-product sales, and reduced expenses related to Year 2000. These results were partially offset by a slowdown in the domestic Capital Markets, volume shortfalls at RRD Direct, the operating issues within the Logistics Services segment mentioned above, additional growth-related expenditures and investments in new systems. Excluding the impact of Stream in 1999, earnings from operations were up 5% from a year ago.
        Consolidated earnings per diluted share in 1999 of $1.39 for the first nine months included a loss from discontinued operations of $0.02 (refer to “Discontinued Operations”).
Consolidated Net Sales and Value-Added Revenue
        Net sales, which includes materials such as paper and ink, increased $34 million in the third quarter of 2000, or 2% from a year ago. Third quarter net sales for the Commercial Print segment, were essentially flat compared with the prior year. The level ofvalue-added revenue represents net sales particularly for our Long-Run Magazines, Catalogs and Inserts operations, is impacted byless the amount of pass-through material sales and paper prices. Third quarter net sales for Long-Run Magazines, Catalogs and Inserts increased 2% from the prior year, which reflected increased volume in the retail and magazine markets and higher paper prices, offset in part by a lower volume of pass-through material sales. Paper prices for the third quarter of 2000 for major grades of paper used within the Long-Run Magazines, Catalogs and Inserts operations were up approximately 7% from a year ago. Third quarter net sales for Telecommunications were down 1% from a year ago primarily due to lower non-directory revenues. Book Publishing Services’ third quarter net sales decreased 5%, primarily reflecting a volume decline within the trade books portion of the consumer market and a lower volume of pass-through material sales. Financial Services’ third quarter net sales were down 8% from a year ago due to the significant slowdown in domestic Capital Markets, only partially offset by higher sales from international Capital Markets and investor communications.
        Net sales increased $286 million in the first nine months of 2000, or 7% from a year ago. Year-to-date net sales for the Commercial Print segment were up 5% from a year ago. Year-to-date net sales for Long-Run Magazines, Catalogs and Inserts increased 2% from the prior year, which reflected volume increases across all major markets and higher paper prices, offset in part by a lower volume of pass-through material sales. Paper prices for the first nine months of 2000 for major grades of paper employed within the Long-Run Magazines, Catalogs and Inserts market were up approximately 4% from a year ago. Net sales for the first nine months of 2000 for Telecommunications were essentially flat compared with the prior year, as an increase in domestic and international directory volumes was offset by a reduction in non-directory revenues. Book Publishing Services’ year-to-date net sales increased 4%, driven by higher volumes within the consumer and educational markets. Financial Services’ year-to-date net sales were up 5% from a year ago, primarily due to higher volume in international Capital Markets.
        Third quarter and year-to-date net sales for the Logistics Services segment more than doubled from a year ago, primarily due to the acquisition of CTC on February 7, 2000 (refer to Note 9). CTC has contributed approximately $84 million and $234 million, respectively, in net sales for the three and nine months ended September 30, 2000. As discussed in Note 6, net sales in 1999 for Donnelley Logistics have been restated to reflect sales on a gross basis, before deducting transportation costs.
        For comparative purposes, third quarter and year-to-date net sales in 1999 included approximately $57 million and $169 million, respectively, of sales from Stream, which we divested in the fourth quarter of 1999 (refer to “Divestitures”).
        The price of paper can be volatile. In periods of rising paper prices, our net sales and cost of materials increase; in periods of falling prices, our net sales and material costs decline.materials. For some customers, we purchase paper used in the printing process and pass through this cost (referred to as “pass through material sales”) at a margin that is lower than print and other related-services;related services; other customers furnish their own paper. Customer-furnished paper is not includedreflected in our financial results. With respect toFor our Logistics Services transportation costs are passed through to our customers and therefore are included in our net sales. Value-addedsegment, value-added revenue represents net sales less the cost of materials (principally paper and ink) and less the cost of transportation related to Logistics Services. Value-addedtransportation. By measuring value-added revenue, eliminateswe eliminate the effects of material prices and transportation costs that are largely beyond our control.
 
        For the third quarter of 2000,Consolidated value-added revenue decreased 3% from a year ago; excluding Stream in 1999, value-added revenue increased 4% from a year ago. This 4% increase was primarily due$29 million, or 3.9%, to acquisitions.
        For the first nine months of 2000, value-added revenue increased 1% from a year ago; excluding Stream in 1999, value-added revenue increased 8% from a year ago. Of this 8% increase, 4% was due to acquisitions.
Consolidated Expenses
        Gross profit for the third quarter of 2000 fell by 5% to $307$728 million compared with $322$758 million a year ago. Excludingin the impact of Stream in 1999, gross profit rose 1% for the thirdfirst quarter of 2000 from a year ago. Gross profit as a percentage2000. Acquisitions contributed an increase of net sales fell to 21.4% for the third quarter of 2000 from 23.0% a year ago. The Logistics Services segment, which has lower gross margins than Commercial Print, represented a higher proportion of consolidated net sales$19 million in the third quarter of 2000 (12% versus 5% for the prior year third quarter), primarily as a result of the CTC acquisition.
        Cost of materialsvalue-added revenue between years. Value-added revenue is impactedaffected by the price of scrap (by-product) paper that we sell. Income from the sale of by-products is recorded as a reduction in our cost of materials. ForDuring the thirdfirst quarter of 2000,2001, we recognized a reduction in our cost of materials of $17$13 million from by-product revenues, which represents a decrease of $3 million from the salefirst quarter of by-products, up $7 million from the third quarter a year ago, primarily as a result of higher by-products prices.2000.
 
        Gross profit for the first nine months of 2000 fell by 1% to $817 million, compared with $824 million a year ago. Gross profit rose 6% for the first nine months of 2000, excluding the impact of Stream in 1999.        Gross profit as a percentage of net sales fell to 19.6% from 21.2% a year ago, primarily due to less profitable work mix within Financial Services andwas 15.3% in the expansionfirst quarter of our lower margin2001 compared with 17.8% in the first quarter of 2000. Our Logistics Services segment, which has lower gross margins than our Commercial Print segment, represented a higher proportion of consolidated net sales in the first nine monthsquarter of 2000 (11%2001 (14.3% versus 5%11.1% in the first quarter of 2000), primarily as a year ago). This decreaseresult of the expansion into package logistics through the acquisition of CTC in February 2000. Commercial Print’s gross margin was partially offset by margin improvements in our core Commercial Print operations (Long-Run Magazines, Catalogs and Insertsdecreased between years primarily due to lower Financial Services’ volume as a result of depressed capital markets, as well as Book Publishing Services) due to productivity improvementsescalating energy and higher by-products pricing. The sale of by-products reduced our cost of materials by $50 million in the first nine months of 2000, up $25 million from the first nine months of 1999.healthcare costs.
 
        Selling and administrative expenses for the third quarter of 2000 were $150decreased $7 million, or 4.5%, to $138 million compared with $164$144 million a year ago. This represented 10.4%in the first quarter of net sales compared with 11.7% a year ago. Spending reductions and cost containment of $13 million coupled with the elimination of Stream expenses ($16 million) and lower Year 2000-related expenses ($7 million), were partially offset by increased spending to expand into complementary businesses ($10 million), higher investment in information systems infrastructure ($6 million) and recent acquisitions ($6 million).
2000. Selling and administrative expenses for the first nine months of 2000 fell by 4%, or $19 million, to $452 million, which represented 10.9%as a percentage of net sales compared with 12.2% a year ago. In addition to cost containment, the declinewas 10.6% in the first nine monthsquarter of 2001 compared with 10.7% in the first quarter of 2000. The majority of the yeardecrease was primarily a result of the elimination of Stream expenses ($46 million), and lower Year 2000-related expenses ($26 million), partially offset by recent acquisitions ($23 million), higher investmentdue to reductions in information systems infrastructure ($15 million) and increased spending to expand into complementary businesses ($20 million).
Summary of Expense Trends
Third Quarter Ended September 30              % Increase
(Thousands of Dollars)
    2000
    1999
    (Decrease)
Cost of materials    $    459,553    $    478,455    (4.0%)
Cost of transportation    133,945    55,461    141.5% 
Cost of manufacturing    436,117    447,171    (2.5%)
Depreciation    81,026    83,038    (2.4%)
Amortization    15,784    13,620    15.9% 
Selling and administrative    149,591    163,965    (8.8%)
Net interest expense    22,810    23,084    (1.2%)
 
Nine Months Ended September 30              % Increase
(Thousands of Dollars)
    2000
    1999
    (Decrease)
Cost of materials    $1,364,533    $1,324,519    3.0% 
Cost of transportation    381,055    154,343    146.9% 
Cost of manufacturing    1,315,248    1,297,069    1.4% 
Depreciation    242,686    242,358    0.1% 
Amortization    44,085    36,158    21.9% 
Selling and administrative    452,456    471,671    (4.1%)
Net interest expense    69,912    66,705    4.8% 
Nonoperating Itemsdiscretionary spending.
 
        InterestNet interest expense fordecreased 20.4% to $18 million in the thirdfirst quarter of 2000 was approximately $23 million, down $0.3 million from a year ago, primarily2001, due to lower debt levels, lower interest rates on commercial paper, and as a result of the suspensionrefinancing $200 million of our share repurchase activity.matured long-term bonds with commercial paper in December 2000, which carries a lower interest rate. Other income, net, decreased $2 million between years primarily due to non-recurring gains on sale of assets in 2000 ($5 million), partially offset by increased miscellaneous expenses in 2000 ($3 million).
 
        OtherExcluding restructuring and impairment charges of $22 million in the first quarter of 2001 (see Note 11 to the condensed consolidated financial statements for additional information), net income net, forof $28 million in the thirdfirst quarter of 2001 decreased 40.3% from $47 million in the first quarter of 2000, while diluted earnings per share decreased 39.5% to $0.23. Including restructuring and impairment charges, net income decreased 68.9% while diluted earnings per share decreased 68.4%. The effective tax rate for the first quarter in both years was $1638.5%.
        The following table shows the trends in net sales and value-added revenue by end market:
First Quarter Ended March 31
    Net Sales
    Value-Added Revenue
Thousands of dollars
    2001
    2000
    % Change
    2001
    2000
    % Change
Long-run Magazines, Catalogs
     and Inserts
    $    442,603    $    451,008    (1.9)%    $275,712    $278,556    (1.0)%
Book Publishing Services    163,653    182,032    (10.1)    117,588    125,633    (6.4)
Financial Services    100,839    133,310    (24.4)    84,154    104,622    (19.6)
Telecommunications    190,494    207,323    (8.1)    84,424    96,263    (12.3)
International (1)    77,599    82,093    (5.5)    35,828    35,869    (0.1)
Specialized Publishing Services    64,958    62,987    3.1     38,955    37,210    4.7 
RRD Direct    46,134    48,161    (4.2)    25,481    26,088    (2.3)
Premedia    27,750    21,761    27.5     27,750    21,523    28.9 
    
  
  
    
  
  
  
Commercial Print    $1,114,030    $1,188,675    (6.3)    $689,891    $725,764    (4.9)
Logistics Services    186,218    149,251    24.8     36,954    27,173    36.0 
Other (2)    2,402    5,044    (52.4)    1,437    4,572    (68.6)
    
  
  
    
  
  
  
          Total    $1,302,650    $1,342,970    (3.0)%    $728,282    $757,508    (3.9)%
    
  
  
    
  
  
  

(1)Includes South America, Poland and Mexico.
(2)Includes other operating segments of the company, including Red Rover.
        A summary analysis of expense trends is presented below:
First Quarter Ended March 31
Thousands of dollars
    2001
    % of Sales
    2000
    % of Sales
    % Change
Cost of materials    $425,105    32.6%    $463,384    34.5%    (8.3)%
Cost of transportation    149,263    11.5     122,078    9.1     22.3 
Cost of manufacturing    446,214    33.1     437,509    31.5     1.8 
Depreciation    81,702    6.3     80,509    6.0     1.5 
Amortization    16,210    1.2     14,378    1.1     12.7 
Selling and administrative expenses    122,627    10.6     129,943    10.7     (4.5)
Restructuring and impairment charges    21,742    1.7     —     0.0     n/a 
Net interest expense    17,624    1.4     22,141    1.6     (20.4)
Operating Results by Business Segment    As discussed more fully in Note 6 to the condensed consolidated financial statements, we have two reportable segments: Commercial Print and Logistics Services. Following our acquisition of CTC in February 2000, we report results from our logistics businesses as a separate business segment within Logistics Services.
        Net sales of our Commercial Print segment, which includes materials such as paper and ink, decreased $75 million in the first quarter of 2001, or 6.3%, from a year ago. The volume of pass-through material sales impacts the level of net sales, particularly for Long-run Magazines, Catalogs and Inserts. First quarter net sales for Long-run Magazines, Catalogs and Inserts decreased 1.9% between years, which reflected volume decreases across all major markets, as well as a lower volume of pass-through material sales. The first quarter 2001 economic slowdown resulted in volume decreases driven by lower magazine and retail insert advertising spending, as well as lower catalog page counts. Paper prices employed within Long-run Magazines, Catalogs and Inserts were up $11 million5% from the same period a year ago.
        Book Publishing Services’ first quarter net sales decreased 10.1% between years due to volume shortfalls and less favorable price/mix, primarily within the education and consumer markets. Book publishers are continuing to work through excess inventories from the year-end 2000 holiday season, and have reduced orders for reprints. First quarter net sales for Telecommunications were down 8.1% between years, primarily due to timing shifts, and to a lesser extent, lower directory volumes. Financial Services’ first quarter net sales decreased 24.4% from a year ago, driven by the slowdown in both U.S. and international capital markets. During the first quarter of 2001, we derived 15% of our capital markets net sales from international, compared with 25% in 2000. For the first quarter, U.S. capital markets volume was down 33.0% between years; international capital markets volume was down 64.1%. Within Financial Services, first quarter net sales from customized communications solutions increased 19.9% between years. First quarter net sales for RRD Direct were down 4.2% between years, with higher volumes in 2001 offset by a reduction in work performed in 2000 for the U.S. census.
        First quarter net sales of our Logistics Services segment increased $37 million, or 24.8%, from a year ago. First quarter net sales of our package logistics business (which includes the acquisition of CTC) were up $46 million, or 70.7%, between years. The increase in net sales for package logistics reflected an additional five weeks of activity in 2001 (CTC was acquired on February 7, 2000), higher prices and higher package volume. First quarter net sales of our print logistics business (freight services and expedited services) decreased $9 million, or 10.4%, between years. The decrease in net sales for print logistics was primarily due to lower expedited services volume related to the first quarter 2001 slowdown in Financial Services. First quarter freight services volume was down between years, which was largely offset by a January 2001 price increase.
        First quarter value-added revenue for the Commercial Print segment decreased $36 million, or 4.9%, from a year ago, largely due to the slowdown in capital markets activity within Financial Services. First quarter value-added revenue for the Logistics Services segment increased $10 million, or 36%, from a year ago. Package logistics contributed an incremental $11 million in value-added revenue between years from the acquisition of CTC. First quarter value-added revenue for print logistics was down $1 million, or 8.2%, driven by higher transportation costs in excess of price increases.
        Excluding restructuring and impairment charges, first quarter earnings from operations for the Commercial Print segment decreased $39 million, or 41.4%, between years. Earnings from operations were affected negatively in the first quarter of 2001 by the slowdown in the U.S. economy, particularly in Financial Services. While softening in the U.S. capital markets began in the fourth quarter of 2000, the slowdown was more severe in the first quarter of 2001, and also spread to the international capital markets. During the fourth quarter of 2000, we had begun initial cost-cutting measures to align spending with market conditions, including downsizing our Financial Services’ operations to reduce our cost base. In the first quarter of 2001, we announced the closure of our financial printing operation in Houston, as well as additional workforce reductions at other facilities. We are continuing to review the cost structure of Financial Services in light of uncertainty in the capital markets.
        The Commercial Print segment’s first quarter earnings from operations were also hurt by the slowdown in the U.S. economy, as volumes were down in both our traditional print businesses (long-run and book), as well as escalating energy and healthcare costs. First quarter earnings from operations were down between years for RRD Direct, primarily as we continue to address operational issues following the consolidation of two direct mail facilities in 2000.
        During first quarter 2001, we recorded a $19.7 million pretax restructuring and impairment charge for the Commercial Print segment. As discussed in Note 11 to the condensed consolidated financial statements, this charge included costs related to the closure of several of our facilities, as well as severance and other exit costs. The $2 million pretax restructuring and impairment charge to write- down the carrying value of two Internet-related technology investments was reflected as a corporate charge for purposes of segment reporting.
        First quarter loss from operations for the Logistics Services segment was $4.6 million, or an additional $4 million loss between years. The first quarter loss from operations for print logistics was $5.7 million unfavorable to the prior year first quarter. This increasedecline in print logistics was driven by higher transportation costs, primarily due to increased carrier and fuel costs in excess of price increases, and consolidation center expansion costs. The improved first quarter performance of package logistics between years reflected a higher-margin customer mix, increased volume, and deeper penetration of the postal system (closer to the final destination). During the fourth quarter of 2000, package logistics had been affected negatively by low prices in response to competition, low margin work and facility start-up costs. Actions taken to-date in 2001 to raise prices and adjust work mix have begun to have a positive impact on package logistics’ results.
        First quarter earnings (loss) from operations within the “Other” operating segment include losses of $7 million and $3 million in 2001 and 2000, respectively, to grow complementary businesses, including Red Rover.
Changes in Financial Condition
Cash Flows Used for Operating Activities
        Cash used in operating activities totaled $25 million in 2001, compared with cash provided by operating activities of $56 million in 2000. The decrease in 2001 was primarily due to a pretax gainhigher investment in operating working capital, a payment related to the settlement of $13 million froma federal tax audit (see Note 7 to the sale of shares received from the demutualization of John Hancock Mutual Life Insurance Company, our basic life insurance carrier.
        Interest expense for the first nine months of 2000condensed consolidated financial statements) and lower net income. The decrease in cash related to operating working capital was approximately $70 million, up $3 million fromdriven by a year ago. This increase wasdecrease in accounts payable, primarily due to higher average commercial paper levels to fund acquisitionslower overall activity and higher commercial paper interest rates.
        Other income, net, for the first nine monthstiming of 2000 was $23 million, up $7 million from the same period a year ago, primarily due to the third quarter demutualization gain noted above. This gain was partially offset by additional foreign currency transaction losses ($4 million).
Discontinued Operations
        For the nine months ended September 30, 1999, we recorded a pretax loss from discontinued operations of $5 million ($3 million after-tax) related to our remaining 86% investment in Corporate Software & Technology (CS&T), a software distribution business. Our ownership interest in CS&T resulted from the restructuring of our 80%-owned investment in Stream International Holdings, Inc. (SIH) in December 1997. In addition to CS&T, SIH held investments in Stream, which provided outsource technical support services, and Modus Media International (MMI), a manufacturing and fulfillment business (refer to “ Divestitures”). As of December 1997, we had converted our equity and debt positions in CS&T to 86% of the common stock of CS&T.
        In November 1999, we sold our entire interest in CS&T to the management of CS&T for cash proceeds of approximately $41 million. We did not recognize any gain or loss from the sale in 1999.
Divestitures
        At the time our ownership interest in SIH was restructured in December 1997, we converted our debt and equity positions in Stream into 87% of the common stock of that business and sold our equity and debt positions in MMI for nonvoting preferred stock of MMI.
        In November 1999, we sold 93% of our investment in the common stock of Stream to a group led by Bain Capital for approximately $96 million in cash. We recognized a pretax gain of $40 million and a tax benefit of $35 million (total of $75 million after-tax) from this transaction. The tax benefit in 1999 was recognized because of our ability to carry back the capital tax losses generated from the sale of Stream to years 1996 through 1998. We now have a 6% investment in Stream, representing the remaining 7% of our original 87% interest, that has been reflected in other noncurrent assets as of September 30, 2000 and December 31, 1999. For reporting purposes, Stream was consolidated in our financial results until November 1999.
        Our 87% ownership interest in Stream for the three and nine months ended September 30, 1999 represented approximately $57 million and $169 million, respectively, in net sales/value-added revenue; $18 million and $52 million, respectively, in gross profit; and $2 million and $5 million, respectively, in earnings from operations. The impact on net income for the three and nine months ended September 30, 1999 from Stream was approximately $1 million and $3 million, respectively, or $0.01 and $0.02, respectively, per diluted share.
        In October 1999, we sold our remaining investment in nonvoting preferred stock of MMI for approximately $60 million ($47 million in cash and a $13 million promissory note due no later than October 2002). The promissory note is interest-bearing at 9.5% per annum, payable quarterly. We recognized both a pretax and after-tax gain of $3 million from this transaction.
        As a result of these divestitures and the sale of CS&T (refer to “Discontinued Operations”), we generated approximately $77 million in refundable income taxes, of which $69 million was received in July 2000, from the carryback of tax losses. The remainder will be applied as a reduction to future federal and state tax payments.
        In June 2000, we sold our interest in RRD India and its wholly-owned subsidiary, Tata Donnelley Ltd., to Tata Sons Limited for approximately $12.5 million in cash; there was no gain or loss recognized from this transaction.
Changes in Financial Condition
Liquidity and Capital Resources
        Net cash provided by operating activities in the first nine months of 2000 totaled $506 million, up $107 million from the prior year. This increase was primarily driven by the receipt of a $69 million tax refund in July 2000 related to the sales of MMI, CS&T and Stream. Cash flow from operations in 1999 was also negatively impacted bypayments, including payment of $22 million in COLI tax-related interest, and a decrease in other accrued liabilities, primarily due to a reduction in the third quarter for settlement of claims madeshare repurchase accrual from year-end, partially offset by the U.S. Attorney and the U.S. Postal Service related to postage due for reorders over a 10-year period ending August 1999.lower receivables.
 
        Capital expenditures during the first nine months of 2000 totaled $181 million compared with $198 millionOur cash conversion cycle (days’ sales outstanding plus days’ inventory on hand minus days’ payable outstanding) continued to improve to 42 days from 44 days a year ago. Spending was directed principallyThe ratio of operating working capital to investmentssales also has continued to improve to 6.2% in 2001 from 6.7% in 2000.
Cash Used for Investing Activities
        Our principal recurring investing activities are capital expenditures to improve the productivity and international expansion. Full-year 2000of operations. In the first quarter, capital expenditures totaled $33 million, a $24 million decrease from a year ago. We expect capital spending is expected to be underbetween $300 million and $350 million in support2001. Over the next 24 months, we plan to invest up to $300 million to improve the efficiency and flexibility of selected opportunities, including expansion ofthe long-run printing and binding operations serving our Poland operationsmagazine, catalog and a new directory plant in Flaxby, England, as well asretail customers. We will make investments to standardizeupgrade plants with fewer, yet wider and upgrade systems company wide. Management believes thatfaster, presses and related equipment to offer customers more flexibility and improved distribution efficiencies with virtually no change to the company’s cash flow and borrowing capacity are sufficient to fund current operations and growth.capacity.
Acquisitions
 
        In February 2000, we purchased CTC, which approximately doubled the sizemade acquisitions and investments to extend our geographic reach and expand our range of our Logistics Services business and expanded our distribution capabilities (refer to Note 9). During the first nine months of 2000, we also acquired Dallas-based Omega Studios, known for producing high-quality digital photography, turnkey creative concept, layout design and desktop publishing services; the Florida financial printer EVACO; the Seattle-based premedia provider Iridio, Inc.; and a leading Brazilian book printer Circulo do Livro. In addition, we invested in Noosh, Inc., a business-to-business Internet-based service designed to improve the process of buying, selling and managing print.capabilities.
 
        In March 1999, we purchased the financial printing unit of Cadmus Communications. The purchase included the assets and operations of five service centersAcquisitions completed in Baltimore, Charlotte, Raleigh, Richmond and New York, as well as a print-on-demand and fulfillment facility in Charlotte and selected software products. In April 1999, we purchased the net assets of the Communicolor division of the Standard Register Company. During the first nine monthsquarter of 1999, we also purchased the net assets of the Brazilian book printer Hamburg Gráfica Editora; the net assets of a California-based transportation company, Freight Systems Inc.; and a 30% equity investment in an Internet website design firm, Multimedia Live.2000 included:
·
Omega Studios–Southwest, Inc. (January 2000)—This dedicated photography studio expanded our premedia offerings in digital photography and creative services, and extended our geographic reach to the Southwest.
·
Iridio, Inc. (February 2000)—This full-service premedia company, which provides digital photography, prepress, digital asset management and digital print services, brought us a significant presence in the Pacific Northwest.
·
Evaco, Inc. (February 2000)—This financial printer based in Florida expanded our Financial Services operations in the Southeast, one of our fastest-growing geographic regions.
·
CTC (February 2000)—This mailer of business-to-home packages in the United States more than doubled the revenue of our Logistics Services segment, enhanced our scale and expanded our service offerings to include the delivery of packages in addition to printed products.
Cash Provided by Financing Activities
 
        Net cash providedFinancing activities include net borrowings, dividend payments and share repurchases. Our net borrowings decreased by borrowings during$70 million year over year, primarily due to acquisition activity in the first nine monthsquarter of 2000 decreased $316 million over the same period from a year ago due to lower share repurchase activity in 2000, as well as higher cash flows from operations. At September 30, 2000,2000. See Acquisitions above.
        Commercial Paper is our primary source of short-term financing. On March 31, 2001, we had an$385 million outstanding in commercial paper borrowing. In addition, at March 31, 2001, we had $438 million unused revolving credit facility of $425 million with a number of banks. This credit facility provides support for the issuance ofissuing commercial paper and other credit needs. Management believes our cash flow and borrowing capability are sufficient to fund operations.
 
Year 2000 and System InfrastructureShare Repurchase
 
        Process controlWe purchased 3.1 million and information systems are increasingly important to the effective management of the company. The upgrade and standardization0.9 million shares of our systems is necessarystock in the first quarter of 2001 and 2000, respectively, for us to succeed$88 million and $21 million, respectively, in using information technology to our strategic advantage. In 1999, we focused our efforts on ensuring that processes and systems were Year 2000 compliant. In addition, we began ongoing initiatives to upgrade and standardize our information technology infrastructure. In 1999, we deferred a number of other infrastructure and systems initiatives that would support continuous productivity improvements and enhance service capabilities, while we completed our Year 2000 efforts.privately negotiated or open-market transactions.
 
        During the transition from 1999 to 2000, all operations were fully supported by trained personnel. Key efforts were focused on four business-critical factors: safety of employees, continuity of production, environmental compliance and reporting, and continuity of systems to support the ability of personnel to continue working (such as the availability of utilities or operation of payroll systems). At the end of the transition, no Year 2000 issues affecting any business-critical factors were reported by any operation. To the extent that date-related issues were reported, they were limited to instances where personnel available at the site were able to promptly correct the issue without disruption to our operations.
        For the nine months ended September 30, 2000, spending on our Year 2000 initiative was $3.7 million, of which $1.4 million was reflected in administrative expense and the remainder in cost of sales. We spent $10.4 million and $41.5 million, respectively, on Year 2000 costs for the three and nine months ended September 30, 1999, of which $6.5 million and $27.1 million, respectively, was reflected in administrative expense and the remainder in cost of sales. These expenses do not include costs capitalized with respect to our information and technology infrastructure upgrade and standardization initiatives. As internal resources completed their Year 2000 assignments, they were reallocated to technology projects that had been deferred, as well as to other productivity projects. These projects are expected to improve our ability to share information across the company, make informed decisions rapidly and enhance future productivity.
Other Information
Share RepurchaseIn September 1999,January 2001, the board of directors authorized a share repurchase program for up to $300 million of the company’s common stock in privately negotiated or open-market transactions. TheSince February 1, under this program includes shares purchased for issuance under various stock option plans. During the first quarter of 2000, we have purchased approximately 0.92.2 million shares at an average priceaggregate cost of $23.75. We suspendedapproximately $61 million.
        Net cash used to repurchase common stock in the programfirst quarter, defined as cash used for share repurchases net of proceeds from stock options exercised, was $114 million and $21 million in 2001 and 2000, respectively. See Note 8 to allowthe condensed consolidated financial statements for a broad reviewsummary of strategic alternatives.shares outstanding.
Other Information
 
Technology—Technology
We remain a technology leader investingand hold 180 patents in print-related technology, including 20 patents in the emerging area of digital printing. We are a leader in technologies such as computer-to-plate, customer connectivity and digital printing,imaging capabilities, as well as Internet-based business models such as Red Rover Digital, and Internet-enabled services such as SENDD™ and ImageMerchant™ (see below for a description of these services). We are focused on investing in technologies that contribute to our financial performance and help us deliver products, services and solutions that are valued by our customers.services.
 
        During 1999 and the first nine months of 2000, we receivedPublic recognition fromeWeekandInformation Weekfor our technology leadership from botheWeek (formerlyPC Week) andInformation Week.Amongefforts in 2000 include the following rankings among all U.S. companies, we were named:companies:
 
·
#3 of the most innovative media and entertainment company users of information technology (Information Week,September 11, 2000)
·
#19 of the top 100 Innovators in E-Business Networking (eWeek,May 8, 2000)
·
#66 of the top 500 e-business leaders (PC Week,November 15, 1999);
 
·
#82 of the top 500 leading IT innovators (Information Week,September 11, 2000); and
·
#19 of the top 100 innovators in e-business networking (eWeek,May 8, 2000).
 
Red Rover Digital, SENDD, ImageMerchant, Digital Print and E-Books—During the second quarter of 2000, we launched Red Rover Digital, Inc. (Red Rover), a wholly-owned subsidiary, formerly our Online Services division. Red Rover is a leading Internet professional services firm that delivers a full spectrum of integrated solutions to enhance its clients’ businesses, brands and customer relationships. Red Rover provides digital communications and commerce solutions to merchants and publishers, helping them maximize content to foster enduring, profitable customer relationships. Content includes the words, images, product information, sound and video that capture and convey our customers’ brands to the market place.Litigation
        Red Rover has helped numerous merchants and publishers enhance business and relationships with their customers. From strategic positioning, through site development and production, to the continuous support of e-business, Red Rover’s comprehensive services are a potent tool for growing successful online brands.
        To meet our Financial Services customers’ needs for speed, convenience, confidentiality and accuracy, we developed SENDD. The software allows work groups around the world to simultaneously proof a document securely via the Internet. Financial Services is also working closely with the Securities and Exchange Commission (SEC) on the modernization efforts under way for EDGAR (Electronic Data Gathering and Retrieval). We currently provide EDGAR electronic filing services for our customers, enabling them to communicate with their target audiences while meeting tight time frames and stringent filing requirements. We will continue to develop our offerings and educate our clients as the SEC enhances EDGAR in the future.
        In our premedia service centers, increased digitization allows us to create, prepare, and manage customer content and distribute it via various communication media, including print and the Internet. We have developed technology that allows a customer to securely archive its digital content in an R.R. Donnelley database and access it at all times via the Internet so that it can be repurposed for multiple uses. This ImageMerchant ASP solution allows customers to more effectively manage their media assets. Customer benefits include lower costs, faster production times, high quality and consistent brand messaging because images and content are repurposed rather than recreated.
        Additionally, we are a leading provider of digital print, which allows customized marketing to an audience of one. With digital printing, images can be varied as they are printed, allowing for each piece to be highly personalized.
        Book Publishing Services also applies technology to create solutions that enable our customers to manage and distribute content in multiple media formats. We currently convert content for many major e-book vendors.
 
        Litigation—In 1996, a purported class action was brought against us in federal district court in Chicago, Illinois, on behalf of all current and former African-American employees, alleging that we racially discriminated against them in violation of the Civil Rights Act of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.). The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seeksought nationwide class certification, most of the specific factual assertions of the complaint relate to the closing of our Chicago catalog operations in 1993. Other general claims relate to other company locations. In August 1999, the district court judge denied our motion for partial summary judgment on the basis of timeliness.
        In 1995, a purported class action was filed against us in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The suit also alleges that we violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. In August 1997, the court certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations.
 
        In 1998, a purported class action was filed against us in federal district court in Chicago on behalf of current and former African-American employees, alleging that the company racially discriminated against them in violation of Title VII of the Civil Rights Act of 1964 (Adams, et al. v. R.R. Donnelley & Sons Co.). While making many of the same general discrimination claims contained in the 1996 case, the plaintiffs in this case also claim retaliation by the company for the filing of discrimination charges or otherwise complaining of race discrimination. The complaint seeks the same relief and damages as sought in the 1996 case.
 
        On April 6, 2001 in an amended opinion, the district court judge in theJonesandAdamscases certified three plaintiff classes in the actions: a class consisting of African-American employees discharged in connection with the shutdown of the Chicago catalog operations; a class consisting of African-American employees of the Chicago catalog operations after November 1992 who were other than permanent employees; and a class consisting of African-Americans subjected to an allegedly hostile working environment at the Chicago catalog operations, the Chicago Financial, Pontiac or Dwight, Illinois, manufacturing operations. The 1996judge also consolidated theJonesandAdamscases for pretrial purposes. On May 1, 2001, the federal court of appeals denied plaintiff’s application for leave to appeal the certification of classes.
        In 1995, a class action was filed against us in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The suit also alleges that we violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. In August 1997, the court certified classes in both the age discrimination and 1995 ERISA claims limited to former employees of the Chicago catalog operations.
        On December 28, 2000, a purported class action was brought against the company and certain of its benefit plans in federal district court in Chicago on behalf of certain former employees of the Chicago catalog operations(Jefferson, et al. v. R.R. Donnelley & Sons Co., et al.).The suit alleges that enhanced pension benefits were not paid to plaintiffs and that plaintiffs are being required to contribute to the costs of retiree medical coverage, both in violation of plan documents and ERISA. The complaint seeks recalculation of pension benefits due plaintiffs since their retirement dates, reimbursement of any amounts paid by plaintiffs for medical coverage, interest on the foregoing amounts, as well as a declaration as to the benefits due plaintiffs in the future.
        TheJones, GerlibandJeffersoncases relate primarily to the circumstances surrounding the closing of the Chicago catalog operations. We believe weThe company believes that it acted properly in the closing of the operations. We also believe we haveoperations, and that certain claims of the classes of former employees of the Chicago catalog operations are untimely. On December 20, 2000, in theJonescase the company filed a renewed motion for partial summary judgment on the basis of timeliness, which is pending. Further, with regard to all cases, the company believes it has a number of valid defenses to all of the claims made and will vigorously defend ourits actions. However, because the cases are in the early stages, we cannotmanagement is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of any of the pending cases.
 
        In December 1999, the U.S. Environmental Protection Agency, Region 5 (U.S. EPA) issued a Notice of Violation against us, pursuant to section 113 of the Clean Air Act (the Act). The notice alleges that our facility in Willard, Ohio, violated the Act and Ohio’s State Implementation Plan in installing and operating certain equipment without appropriate air permits. While the notice does not specify the remedy sought, upon final determination of a violation, the U.S. EPA may issue an administrative order requiring the installation of air pollution control equipment, assess penalties, or commence civil or criminal action against us. We responded to U.S. EPA on March 10, 2000. We do not believe that any unfavorable resultthe resolution of this proceedingmatter, even if unfavorable to us, will have a materialnot materially impact on our financial position or results of operations.
 
        In addition, we are a party to certain litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the operations or financial condition of the company.
 
        Environmental Regulations—Health and Safety—Our business is subject to various laws and regulations relating togoverning employee health and safety and to environmental protection. Our policy is to comply with all laws and regulations that govern protection of the environmentregulations. Our overriding principles are to create sustainable compliance and employee health and safety.an injury-free workplace. We do not anticipate that compliance will have a material adverse effect on our competitive or consolidated financial positions.position.
 
        Outlook—Our primary business remains commercial printing and our primary geographic market is the United States. The environment remainsis highly competitive in most of our product categories and geographic regions. Competition is based largely on price, quality and servicing the special needs of customers. Industry analysts believe that there is overcapacity in most commercial printing markets. Therefore, competition is intense. Our intent is to differentiate our service offeringofferings so that we are viewed by our customers as a partner who can help them more effectively use wordsdeliver effective and imagestargeted communications in a variety of ways, whether through print or the Internet,right format to reach their target audiences.the right audience at the right time.
 
        We are a large user of paper, bought by us or supplied to us by our customers.customers or bought by us. The cost and supply of certain paper grades used in the manufacturing process will continue to affect our financial results. However, management currently does not see any disruptive conditions affecting prices and supply of paper in 2000.2001.
 
        Postal costs are a significant component of our customers’ cost structures. Changes in postal rates whichwent into effect in January 2001 and are anticipated earlyexpected to increase again in 2001, mayJuly 2001. These increases are not expected to negatively affect the demand for our core print capabilities, but the proposedcompany. In fact, postal rate increases will enhance the value of Donnelley Logistics Services to our customers, as we are able to improve the cost efficiency of mail processing and distribution. This ability to deliver mail on a more precise schedule and at a lower relative cost should enhance our position in the marketplace.
        The cost of energy affects our operating costs in the Commercial Print segment and transportation costs in Logistics Services. In Logistics Services, increases in fuel costs can be offset by fuel surcharges passed on to customers, but continuing increases in other energy costs could affect our consolidated financial results.
 
        In addition, to paper and postage costs, consumer confidence and economic growth are key drivers of print demand. Ademand for our services and a significant change in the economic outlook could affect us. The slowdown experienced in U.S. capital markets in the fourth quarter of 2000 has continued into 2001, negatively affecting our Financial Services business. However, growth in demand for customized communications solutions for investment management, banking, insurance, managed care and pharmaceutical companies provides opportunities for our products, as evidenced byFinancial Services business to partially offset the recent slowdown in domestic Capital Markets which we expect to continue through the end of the year.U.S. capital markets slowdown.
 
        In the longer term, technological changes, including the electronic distribution of information, present both risks and opportunities for the company. Many of our new business initiatives are designed to leverage our distinctive capabilities to participate in the rapid growth in electronic communications. Our goal remains to manage and distribute words and images, regardless of the means of distribution, to help our customers succeed by delivering effective and targeted communications in informing, educating, entertaining and selling.the right format to the right audience at the right time. We believe that with our competitive strengths, including our comprehensive service offerings, technology leadership, depth of management experience, customer relationships and economies of scale, we can develop the most valuable solutions for our customers, which should result in increased shareholder value.
 
Item 3
 
Quantitative and Qualitative Disclosures About Market Risk
 
        We areThe company is exposed to market risk from changes in interest rates and foreign exchange rates. However, wethe company generally maintainmaintains more than half of ourits debt at fixed rates (approximately 64%62% at September 30, 2000)March 31, 2001), and ourtherefore its exposure to short-term interest rate fluctuations is not materialimmaterial to the consolidated financial statements of the company as a whole. OurThe company’s exposure to adverse changes in foreign exchange rates also is immaterial to ourthe consolidated financial statements of the company as a whole, and wethe company occasionally useuses financial instruments to hedge exposures to foreign exchange rate changes. We doThe company does not use financial instruments for trading purposes and areis not a party to any leveraged derivatives. FurtherFor further disclosure relating to financial instruments issee the “Debt Financing and Interest Expense” footnote to the consolidated financial statements included in the Debt Financing and Interest Expense note in the Notes to Consolidated Financial Statements included in our 1999company’s 2000 Annual Report on Form 10-K.
 
PART II
 
OTHER INFORMATION
 
Item 1. Legal Proceedings
 
        On each of November 25, 1996, and June 30, 1998, purported class actions were brought against the company alleging racial discrimination and seeking actual, compensatory, consequential and punitive damages in an amount not less than $500 million. On December 18, 1995, a class action was brought against the company alleging age discrimination in connection with the 1993 closing of the company’s Chicago catalog operations, and violation of the Employee Retirement Income Security Act.Act (ERISA). On December 28, 2000, a purported class action was brought against the company alleging failure to calculate pension benefits for former employees of the company’s Chicago catalog operations in accordance with plan documents and ERISA. These actions are described in Part I of this quarterly report on Form 10-Q.
 
Item 4. Submission of Matters to a Vote of Security Holders
        (a) The company held its Annual Meeting of Stockholders on March 22, 2001.
        (b) The following matters were voted upon at the Annual Meeting of Stockholders:
        1. The election of the nominees for Directors of Class 1, who will serve for a term to expire at the Annual Meeting of Stockholders to be held in 2004, was voted on by the stockholders. The nominees, all of whom were elected, were Martha Layne Collins, William L. Davis, Oliver R. Sockwell and Stephen M. Wolf. The Inspectors of Election certified the following vote tabulations:
     For
    Withheld
Martha Layne Collins    99,583,067    900,355
William L. Davis    99,642,664    840,758
Oliver R. Sockwell    99,585,760    897,662
Stephen M. Wolf    99,591,128    892,294
Item 5. Other Information
 
        Certain statements in this filing, including the discussions of management expectations for 2000,2001, constitute “ forward-looking“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from the future results expressed or implied by those statements. Refer to Part I, Item 1 of the company’s 19992000 Annual Report on Form 10-K for a description of such factors.
 
Item 6. Exhibits and Reports on Form 8-K.
 
        (a)Exhibits
 
4364-Day Credit Agreement dated October 12, 2000 among the Company, the Banks
named therein and Bank One, NA, as Administrative Agent
12    Ratio of Earnings to Fixed Charges
27Financial Data Schedule
 
        (b) No current report on Form 8-K was filed during the thirdfirst quarter of 2000.2001.
 
SIGNATURE
 
        Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
R.R. DONNELLEY & SONS COMPANY
 
      /S /    VIRGINIA L. SEGGERMAN
By 
Corporate Controller
(Authorized Officer and
Chief Accounting Officer)
 
November 13, 2000May 14, 2001
Date