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, 2002March 31, 2003
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 (State or other jurisdiction of incorporation or organization) | 36-1004130 (I.R.S. Employer Identification No.) | |
77 West Wacker Drive, (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.
Yes ü | No |
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)
Yesü | No |
Number of shares of common stock | ||
outstanding as of |
|
PART I
Item 1. Financial Statements
Page Number(s) | ||||
3 | ||||
4 | ||||
5 | ||||
6 - | ||||
Item 2. Management’s Discussion and Analysis of Financial Condition and Results | ||||
17 - | ||||
20 - | ||||
28 - | ||||
30 | ||||
31 | ||||
31 | ||||
PART II OTHER INFORMATION | ||||
32 | ||||
32 | ||||
32 | ||||
33 |
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Thousands of dollars,In thousands, except per shareper-share data)
Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||
Net sales | $ | 1,177,280 | $ | 1,288,237 | $ | 3,419,822 | $ | 3,882,937 | ||||||||
Cost of sales | 935,101 | 1,050,616 | 2,815,484 | 3,223,461 | ||||||||||||
Gross profit | 242,179 | 237,621 | 604,338 | 659,476 | ||||||||||||
Selling and administrative expenses | 134,223 | 135,438 | 401,564 | 417,827 | ||||||||||||
Restructuring and impairment charges | 22,709 | 19,860 | 65,426 | 91,895 | ||||||||||||
Earnings from operations | 85,247 | 82,323 | 137,348 | 149,754 | ||||||||||||
Other income (expense): | ||||||||||||||||
Interest expense | (16,937 | ) | (18,831 | ) | (49,683 | ) | (55,132 | ) | ||||||||
Other, net | 6,391 | 4,870 | 12,447 | 7,320 | ||||||||||||
Earnings before income taxes | 74,701 | 68,362 | 100,112 | 101,942 | ||||||||||||
Provision for income taxes | 26,959 | 26,320 | 5,934 | 39,248 | ||||||||||||
Net income | $ | 47,742 | $ | 42,042 | $ | 94,178 | $ | 62,694 | ||||||||
Net income per share of common stock | ||||||||||||||||
Basic | $ | 0.42 | $ | 0.36 | $ | 0.83 | $ | 0.53 | ||||||||
Diluted | 0.42 | 0.36 | 0.82 | 0.53 |
Three Months Ended | ||||||||
2003 | 2002 | |||||||
Net sales | $ | 1,073,817 |
| $ | 1,093,650 |
| ||
Cost of sales |
| 905,507 |
|
| 925,745 |
| ||
Gross profit |
| 168,310 |
|
| 167,905 |
| ||
Selling and administrative expenses |
| 138,778 |
|
| 130,522 |
| ||
Restructuring and impairment charges |
| 2,609 |
|
| 26,692 |
| ||
Earnings from operations |
| 26,923 |
|
| 10,691 |
| ||
Interest expense, net |
| (12,707 | ) |
| (15,453 | ) | ||
Other income (expense), net |
| (4,943 | ) |
| (6,891 | ) | ||
Earnings (loss) before income taxes |
| 9,273 |
|
| (11,653 | ) | ||
Provision (benefit) for income taxes |
| 3,571 |
|
| (34,312 | ) | ||
Net income | $ | 5,702 |
| $ | 22,659 |
| ||
Net income per share of common stock | ||||||||
Basic | $ | 0.05 |
| $ | 0.20 |
| ||
Diluted |
| 0.05 |
|
| 0.20 |
| ||
Weighted average number of common shares outstanding | ||||||||
Basic |
| 113,101 |
|
| 112,894 |
| ||
Diluted |
| 113,696 |
|
| 114,824 |
|
See accompanying Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, 2002March 31, 2003 and December 31, 20012002
(Thousands of dollars, except share data)
ASSETS | ||||||||
2002 | 2001 | |||||||
Cash and equivalents | $ | 72,148 | $ | 48,615 | ||||
Receivables, less allowance for doubtful accounts of $21,503 in 2002 and $22,571 in 2001 | 647,739 | 681,459 | ||||||
Inventories | 132,418 | 126,718 | ||||||
Prepaid expenses | 60,328 | 83,402 | ||||||
Total current assets | 912,633 | 940,194 | ||||||
Net property, plant and equipment, at cost, less accumulated depreciation of $3,213,946 in 2002 and $3,148,018 in 2001 | 1,428,298 | 1,490,118 | ||||||
Goodwill, net of accumulated amortization of $57,655 in 2002 and $70,017 in 2001 | 307,026 | 312,613 | ||||||
Other intangible assets, net of accumulated amortization of $245,271 in 2002 and $243,405 in 2001 | 108,257 | 127,936 | ||||||
Other noncurrent assets | 513,128 | 514,756 | ||||||
Total assets | $ | 3,269,342 | $ | 3,385,617 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Accounts payable | $ | 265,786 | $ | 295,444 | ||||
Accrued compensation | 166,453 | 162,573 | ||||||
Short-term debt | 310,410 | 168,497 | ||||||
Current and deferred income taxes | 20,560 | 46,849 | ||||||
Other accrued liabilities | 339,836 | 310,927 | ||||||
Total current liabilities | 1,103,045 | 984,290 | ||||||
Long-term debt | 775,296 | 881,318 | ||||||
Deferred income taxes | 228,445 | 212,099 | ||||||
Other noncurrent liabilities | 312,988 | 419,503 | ||||||
Total noncurrent liabilities | 1,316,729 | 1,512,920 | ||||||
Shareholders’ equity: | ||||||||
Common stock at stated value ($1.25 par value) | ||||||||
Authorized shares: 500,000,000; Issued 140,889,050 in 2002 and 2001 | 308,462 | 308,462 | ||||||
Retained earnings | 1,543,281 | 1,569,596 | ||||||
Accumulated other comprehensive loss | (129,486 | ) | (109,002 | ) | ||||
Unearned compensation | (5,765 | ) | (6,998 | ) | ||||
Reacquired common stock, at cost, 27,570,701 shares in 2002 and 27,439,636 shares in 2001 | (866,924 | ) | (873,651 | ) | ||||
Total shareholders’ equity | 849,568 | 888,407 | ||||||
Total liabilities and shareholders’ equity | $ | 3,269,342 | $ | 3,385,617 | ||||
ASSETS | ||||||||
2003 | 2002 | |||||||
Cash and equivalents | $ | 40,483 |
| $ | 60,543 |
| ||
Receivables, less allowance for doubtful accounts of $25,770 in 2003 |
| 567,471 |
|
| 601,184 |
| ||
Inventories |
| 147,264 |
|
| 116,191 |
| ||
Prepaid expenses |
| 69,604 |
|
| 88,521 |
| ||
Total current assets |
| 824,822 |
|
| 866,439 |
| ||
Net property, plant and equipment, at cost, less accumulated depreciation of $3,159,559 in 2003 and $3,206,942 in 2002 |
| 1,390,222 |
|
| 1,411,016 |
| ||
Goodwill |
| 306,915 |
|
| 308,174 |
| ||
Other intangible assets, net of accumulated amortization of $264,007 in 2003 and $259,477 in 2002 |
| 92,651 |
|
| 96,662 |
| ||
Other noncurrent assets |
| 492,733 |
|
| 469,481 |
| ||
Total assets | $ | 3,107,343 |
| $ | 3,151,772 |
| ||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Accounts payable | $ | 252,397 |
| $ | 267,690 |
| ||
Accrued compensation |
| 145,527 |
|
| 157,070 |
| ||
Short-term debt |
| 246,151 |
|
| 245,782 |
| ||
Current and deferred income taxes |
| 2,587 |
|
| 1,397 |
| ||
Other accrued liabilities |
| 312,326 |
|
| 282,791 |
| ||
Total current liabilities |
| 958,988 |
|
| 954,730 |
| ||
Long-term debt |
| 757,994 |
|
| 752,870 |
| ||
Deferred income taxes |
| 214,068 |
|
| 214,112 |
| ||
Other noncurrent liabilities |
| 313,921 |
|
| 315,466 |
| ||
Total noncurrent liabilities |
| 1,285,983 |
|
| 1,282,448 |
| ||
Shareholders’ equity: | ||||||||
Common stock at stated value ($1.25 par value) | ||||||||
Authorized shares: 500,000,000; Issued 140,889,050 in 2003 and 2002 |
| 308,462 |
|
| 308,462 |
| ||
Retained earnings |
| 1,540,268 |
|
| 1,593,107 |
| ||
Accumulated other comprehensive loss |
| (116,927 | ) |
| (115,456 | ) | ||
Unearned compensation |
| (5,928 | ) |
| (5,177 | ) | ||
Reacquired common stock at cost, 27,795,679 and 27,764,983 at 2003 and 2002, respectively |
| (863,503 | ) |
| (866,342 | ) | ||
Total shareholders’ equity |
| 862,372 |
|
| 914,594 |
| ||
Total liabilities and shareholders’ equity | $ | 3,107,343 |
| $ | 3,151,772 |
| ||
See accompanying Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the NineThree Months Ended September 30March 31
(Thousands of dollars)
2002 | 2001 | |||||||
Cash flows provided by (used for) operating activities: | ||||||||
Net income | $ | 94,178 | $ | 62,694 | ||||
Restructuring and impairment charges | 65,426 | 91,895 | ||||||
Gain from reversal of excess tax reserves | (30,000 | ) | — | |||||
Loss on write-down of investments | — | 2,040 | ||||||
Depreciation | 217,503 | 239,319 | ||||||
Amortization | 29,139 | 43,097 | ||||||
Gain on sale of assets and investments | (13,785 | ) | (6,637 | ) | ||||
Net change in operating working capital | 865 | (77,409 | ) | |||||
Net change in other assets and liabilities | (118,593 | ) | (42,513 | ) | ||||
Other | 263 | 8,342 | ||||||
Net cash provided by operating activities | 244,996 | 320,828 | ||||||
Cash flows provided by (used for) investing activities: | ||||||||
Capital expenditures | (182,269 | ) | (162,806 | ) | ||||
Other investments including acquisitions | 182 | (2,326 | ) | |||||
Dispositions of assets and investments | 24,459 | 7,611 | ||||||
Net cash used for investing activities | (157,628 | ) | (157,521 | ) | ||||
Cash flows provided by (used for) financing activities: | ||||||||
Repayments of long-term debt | (75,083 | ) | (4,428 | ) | ||||
Short-term borrowings, net | 103,056 | 101,118 | ||||||
Disposition of reacquired common stock | 13,011 | 18,179 | ||||||
Acquisition of common stock | (19,356 | ) | (215,282 | ) | ||||
Cash dividends paid | (82,633 | ) | (82,505 | ) | ||||
Net cash used for financing activities | (61,005 | ) | (182,918 | ) | ||||
Effect of exchange rate changes on cash and equivalents | (2,830 | ) | (555 | ) | ||||
Net change in cash and equivalents | 23,533 | (20,166 | ) | |||||
Cash and equivalents at beginning of period | 48,615 | 60,873 | ||||||
Cash and equivalents at end of period | $ | 72,148 | $ | 40,707 | ||||
Changes in operating working capital: | ||||||||
Decrease (increase) in assets: | ||||||||
Receivables—net | $ | 33,787 | $ | 36,252 | ||||
Inventories—net | (10,641 | ) | 15,145 | |||||
Prepaid expenses | 22,488 | 6,391 | ||||||
Increase (decrease) in liabilities: | ||||||||
Accounts payable | (31,257 | ) | (91,818 | ) | ||||
Accrued compensation | 4,669 | (16,108 | ) | |||||
Other accrued liabilities | (18,181 | ) | (27,271 | ) | ||||
Net change in operating working capital | $ | 865 | $ | (77,409 | ) | |||
2003 | 2002 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 5,702 |
| $ | 22,659 |
| ||
Restructuring and impairment charges |
| 2,609 |
|
| 26,692 |
| ||
Gain from reversal of excess tax reserves |
| — |
|
| (30,000 | ) | ||
Depreciation |
| 68,236 |
|
| 72,120 |
| ||
Amortization |
| 9,038 |
|
| 9,747 |
| ||
Gain on sale of assets |
| (1,945 | ) |
| (888 | ) | ||
Net change in operating working capital, net of acquisition |
| (6,812 | ) |
| (29,230 | ) | ||
Net change in other assets and liabilities, net of acquisition |
| (12,851 | ) |
| 7,206 |
| ||
Other |
| 4,459 |
|
| (5,510 | ) | ||
Net cash flows from operating activities |
| 68,436 |
|
| 72,796 |
| ||
Cash flows from investing activities: | ||||||||
Capital expenditures |
| (50,022 | ) |
| (65,818 | ) | ||
Other investments including acquisition, net of cash acquired |
| (17,000 | ) |
| 87 |
| ||
Dispositions of assets |
| 3,096 |
|
| 957 |
| ||
Net cash flows from investing activities |
| (63,926 | ) |
| (64,774 | ) | ||
Cash flows from financing activities: | ||||||||
Repayments of long-term debt |
| (110,110 | ) |
| (728 | ) | ||
Long-term borrowings |
| 566 |
|
| 1,592 |
| ||
Net proceeds from short-term borrowings |
| 113,280 |
|
| 32,782 |
| ||
Disposition of reacquired common stock |
| 896 |
|
| 4,107 |
| ||
Acquisition of common stock |
| (693 | ) |
| (17,693 | ) | ||
Cash dividends paid |
| (28,326 | ) |
| (27,108 | ) | ||
Net cash flows from financing activities |
| (24,387 | ) |
| (7,048 | ) | ||
Effect of exchange rate changes on cash and equivalents |
| (183 | ) |
| (359 | ) | ||
Net change in cash and equivalents |
| (20,060 | ) |
| 615 |
| ||
Cash and equivalents at beginning of period |
| 60,543 |
|
| 48,615 |
| ||
Cash and equivalents at end of period | $ | 40,483 |
| $ | 49,230 |
| ||
Changes in operating working capital, net of acquisition:
2003 | 2002 | |||||||
Decrease (increase) in assets: | ||||||||
Receivables-net | $ | 34,307 |
| $ | 34,544 |
| ||
Inventories-net |
| (31,303 | ) |
| 2,840 |
| ||
Prepaid expenses |
| 19,150 |
|
| (10,773 | ) | ||
Increase (decrease) in liabilities: | ||||||||
Accounts payable |
| (16,513 | ) |
| (41,690 | ) | ||
Accrued compensation |
| (11,497 | ) |
| (15,077 | ) | ||
Other accrued liabilities |
| (956 | ) |
| 926 |
| ||
Net change in operating working capital | $ | (6,812 | ) | $ | (29,230 | ) | ||
See accompanying Notes to Condensed Consolidated Financial Statements.
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, 20012002 is derivedcondensed 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 20012002 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, 2002,March 31, 2003, and December 31, 2001,2002, were as follows:
Thousands of dollars | 2002 | 2001 | ||||||
Raw materials and manufacturing supplies | $ | 88,072 | $ | 100,206 | ||||
Work in process | 164,060 | 112,333 | ||||||
Finished goods | 771 | 904 | ||||||
Progress billings (1) | (66,381 | ) | (32,621 | ) | ||||
LIFO reserve | (54,104 | ) | (54,104 | ) | ||||
Total | $ | 132,418 | $ | 126,718 | ||||
(1) Progress billings represent customer prepayment for raw materials or work in process. | ||||||||
NOTE 3.The following provides supplemental cash flow information: | ||||||||
Nine Months Ended September 30 | ||||||||
Thousands of dollars | 2002 | 2001 | ||||||
Interest paid (1) | $ | 42,809 | $ | 43,629 | ||||
Income taxes paid (2) | $ | 176,700 | $ | 72,794 |
Thousands of dollars | 2003 | 2002 | ||||||
Raw materials and manufacturing supplies | $ | 88,169 |
| $ | 83,701 |
| ||
Work in process |
| 136,131 |
|
| 108,947 |
| ||
Finished goods |
| 3,213 |
|
| 1,824 |
| ||
Progress billings |
| (29,697 | ) |
| (28,977 | ) | ||
LIFO reserve |
| (50,552 | ) |
| (49,304 | ) | ||
Total | $ | 147,264 |
| $ | 116,191 |
| ||
Progress billings represent customer prepayment for raw materials or work in progress.
| ||||||||
NOTE 3. The following provides supplemental cash flow information: | ||||||||
Three Months Ended | ||||||||
Thousands of dollars | 2003 | 2002 | ||||||
Interest paid | $ | 6,409 |
| $ | 5,493 |
| ||
Income taxes paid |
| 1,412 |
|
| 7,993 |
|
NOTE 4. On November 25, 1996, a class action was brought againstAs reported in the company’s Annual Report on Form 10-K for 2002, the company in federal district court in Chicago, Illinois, on behalfhas settled three previously pending cases:Adams, et al. v. R.R. Donnelley & Sons Co; Jefferson, et al. v. R.R. Donnelley & Sons Co., et al,andGerlib, et al. v. R.R. Donnelley & Sons Co. without any admission of current and former African-American employees, allegingwrongdoing by the company. The company also settled that the company racially discriminated against them in violationportion of the Civil Rights Act of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.Co)., relating to claims arising in locations other than the Chicago catalog operations without any admission of wrongdoing by the company. The complaint seeks declaratorycompany recorded a total pretax charge of $16 million in 2002 ($9 million in the second quarter and injunctive relief,$7 million in the fourth quarter) relating to these settlements. The district court approved the settlement inAdams/Jones at a hearing in March 2003, and asks for actual, compensatory, consequential and punitive damagesapproved the settlement in anGerlib/Jefferson at a hearing in April 2003.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
On June 30, 1998, a class action was filed against the company 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 containedThe issue remaining in theJonescomplaint, theAdamsplaintiffs are also claiming retaliation case affects two classes certified 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 theJonescase.
From time to time, customers of the company file voluntary petitions for reorganization under the United States bankruptcy laws. In such cases, certain pre-petition payments received by the company could be considered preference items and subject to return to the bankruptcy administrator. The company believes that the final resolution of these matters.
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 operationscompany’s consolidated financial position or financial conditionresults of the company.
Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||||
Thousands of dollars | 2002 | 2001 | 2002 | 2001 | ||||||||||||
Net income | $ | 47,742 | $ | 42,042 | $ | 94,178 | $ | 62,694 | ||||||||
Unrealized foreign currency loss | (7,202 | ) | (9,144 | ) | (20,484 | ) | (17,199 | ) | ||||||||
Comprehensive income | $ | 40,540 | $ | 32,898 | $ | 73,694 | $ | 45,495 | ||||||||
Three Months Ended March 31 | ||||||||
Thousands of dollars | 2003 | 2002 | ||||||
Net income | $ | 5,702 |
| $ | 22,659 |
| ||
Unrealized foreign currency loss |
| (1,471 | ) |
| (8,791 | ) | ||
Comprehensive income | $ | 4,231 |
| $ | 13,868 |
| ||
NOTE 6.The company operates primarily in the commercial print portion of the printing industry, with related service offerings designed to offer customers complete solutions for communicating theirmessagestheir messages to target audiences. Beginning January 1, 2002,2003, the company revised its segment reporting to reflect changes in how it operates and reports internally its businesses.RR Donnelley Financial (Financial Services) as a separate business segment. The company’s Financial Services operations were previously reported within the Other business segment. As a result, of these changes, thecompany nowthe company discloses twothree reportable segments: Donnelley Print Solutions, Logistics Services and LogisticsFinancial Services. R.R.
RR Donnelley Print Solutions (Donnelley Print Solutions) is comprised of the company’s businessesservingbusinesses serving the following end markets within the commercial print industry: Magazines, CatalogsMagazine, Catalog and Retail; Book Publishing Services; Telecommunications; and Premedia Technologies. Donnelley Print SolutionswasSolutions was created to optimize the company’s production capacity serving these end markets, and to enhance
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
service delivery capabilities. The formation of Donnelley Print Solutions in 2002 was intended to create a more cost-effective, integrated and flexible print platform using a single business model and operating under one management team.
RR Donnelley Logistics (Donnelley Logistics) represents the company’s logistics and distribution services operations for its print customers and other mailers. Donnelley Logistics servesservices its customers by consolidating and delivering printed products and packages to the U.S. Postal Service closer to the final destination, resulting in reduced postage costs and improved delivery performance. Operating results for Donnelley Logistics are included under the reportable segment “Logistics Services.”
RR Donnelley Financial serves the domestic and international capital markets, and provides customized communications solutions to January 1, 2002, the company disclosed two reportable segments: Commercial Printinvestment management, banking, managed care, and Logistics Services. Results previously reported within the Commercial Print segment included the company’s businesses serving the following end markets: Magazines, Catalogsinsurance clients to help manage and Retail (including Specialized Publishing Services); Book Publishing Services; Telecommunications; Premedia Technologies; Financial Services; RRD Direct (direct mail); and International, which provides similar products and services outside the U.S. Following the formation of Donnelley Print Solutions, the operating results for Financial Services, RRD Direct and International are included in “Other” for segment reporting purposes. Prior year results have been restated to conform to the new segment presentation.
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 “Critical Accounting Policies” section of Management’s Discussion and Analysis of
Industry Segment Information
Thousands of dollars | Donnelley Print Solutions | Logistics Services | Other (1) | Corporate | Consolidated Total | |||||||||||||
Three Months Ended September 30, 2002 | ||||||||||||||||||
Net sales | $ | 771,291 | $ | 192,896 | $ | 213,093 | $ | — | $ | 1,177,280 | ||||||||
Restructuring and impairment charges | 6,562 | 286 | 3,088 | 12,773 | 22,709 | |||||||||||||
Earnings (loss) from operations | 106,890 | 2,159 | (12,104 | ) | (11,698 | ) | 85,247 | |||||||||||
Earnings (loss) before income taxes | 110,131 | 2,160 | (8,049 | ) | (29,541 | ) | 74,701 | |||||||||||
Three Months Ended September 30, 2001 | ||||||||||||||||||
Net sales | $ | 856,585 | $ | 190,059 | $ | 241,593 | $ | — | $ | 1,288,237 | ||||||||
Restructuring and impairment charges | 7,928 | 190 | 11,742 | — | 19,860 | |||||||||||||
Earnings (loss) from operations | 96,966 | 236 | (26,892 | ) | 12,013 | 82,323 | ||||||||||||
Earnings (loss) before income taxes | 100,239 | 353 | (26,458 | ) | (5,772 | ) | 68,362 | |||||||||||
Nine Months Ended September 30, 2002 | ||||||||||||||||||
Net sales | $ | 2,202,029 | $ | 541,565 | $ | 676,228 | $ | — | $ | 3,419,822 | ||||||||
Restructuring and impairment charges | 43,716 | 408 | 7,120 | 14,182 | 65,426 | |||||||||||||
Earnings (loss) from operations | 178,134 | 7,216 | (36,211 | ) | (11,791 | ) | 137,348 | |||||||||||
Earnings (loss) before income taxes | 188,933 | 7,174 | (38,159 | ) | (57,836 | ) | 100,112 | |||||||||||
Assets | 1,701,900 | 233,646 | 659,351 | 674,445 | 3,269,342 | |||||||||||||
Nine Months Ended September 30, 2001 | ||||||||||||||||||
Net sales | $ | 2,540,559 | $ | 562,395 | $ | 779,983 | $ | — | $ | 3,882,937 | ||||||||
Restructuring and impairment charges | 69,666 | 281 | 18,252 | 3,696 | 91,895 | |||||||||||||
Earnings (loss) from operations | 176,958 | (7,566 | ) | (64,200 | ) | 44,562 | 149,754 | |||||||||||
Earnings (loss) before income taxes | 186,502 | (7,478 | ) | (62,307 | ) | (14,775 | ) | 101,942 | ||||||||||
Assets | 1,964,942 | 245,255 | 800,497 | 628,109 | 3,638,803 |
Thousands of dollars | Donnelley Solutions | Logistics Services | Financial Services | Other (1) | Corporate | Consolidated Total | ||||||||||||||||
Three months ended March 31, 2003 | ||||||||||||||||||||||
Net sales | $ | 666,973 | $ | 209,808 | $ | 90,255 |
| $ | 106,781 |
| $ | — |
| $ | 1,073,817 |
| ||||||
Restructuring and impairment charges |
| 169 |
| — |
| 573 |
|
| 715 |
|
| 1,152 |
|
| 2,609 |
| ||||||
Earnings (loss) from operations |
| 45,682 |
| 3,543 |
| (6,362 | ) |
| (9,045 | ) |
| (6,895 | ) |
| 26,923 |
| ||||||
Earnings (loss) before income taxes |
| 45,707 |
| 3,517 |
| (6,522 | ) |
| (10,858 | ) |
| (22,571 | ) |
| 9,273 |
| ||||||
Assets |
| 1,615,131 |
| 256,792 |
| 178,391 |
|
| 511,049 |
|
| 545,980 |
|
| 3,107,343 |
| ||||||
Three months ended March 31, 2002 | ||||||||||||||||||||||
Net sales | $ | 714,334 | $ | 172,079 | $ | 102,875 |
| $ | 104,362 |
| $ | — |
| $ | 1,093,650 |
| ||||||
Restructuring and impairment charges |
| 23,122 |
| 24 |
| 21 |
|
| 2,387 |
|
| 1,138 |
|
| 26,692 |
| ||||||
Earnings (loss) from operations |
| 23,978 |
| 3,043 |
| (12,262 | ) |
| (14,494 | ) |
| 10,426 |
|
| 10,691 |
| ||||||
Earnings (loss) before income taxes |
| 27,109 |
| 2,981 |
| (12,074 | ) |
| (19,397 | ) |
| (10,272 | ) |
| (11,653 | ) | ||||||
Assets |
| 1,747,355 |
| 227,460 |
| 228,102 |
|
| 469,670 |
|
| 657,479 |
|
| 3,330,066 |
|
(1) | Represents other operating segments of the company, including |
Net Sales | ||||||||||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||
Thousands of dollars | 2002 | 2001 | % Change | 2002 | 2001 | % Change | ||||||||||||
Magazines, Catalogs and Retail | $ | 387,643 | $ | 446,579 | (13.2 | )% | $ | 1,127,493 | $ | 1,363,801 | (17.3 | )% | ||||||
Book Publishing Services | 193,882 | 199,505 | (2.8 | )% | 526,349 | 542,220 | (2.9 | )% | ||||||||||
Telecommunications | 158,756 | 174,162 | (8.8 | )% | 459,374 | 527,731 | (13.0 | )% | ||||||||||
Premedia Technologies | 31,010 | 36,339 | (14.7 | )% | 88,813 | 106,807 | (16.8 | )% | ||||||||||
Donnelley Print Solutions | 771,291 | 856,585 | (10.0 | )% | 2,202,029 | 2,540,559 | (13.3 | )% | ||||||||||
Logistics Services | 192,896 | 190,059 | 1.5 | % | 541,565 | 562,395 | (3.7 | )% | ||||||||||
Financial Services | 93,482 | 117,233 | (20.3 | )% | 340,949 | 391,635 | (12.9 | )% | ||||||||||
RRD Direct | 33,828 | 46,148 | (26.7 | )% | 104,752 | 132,394 | (20.9 | )% | ||||||||||
International (2) | 85,783 | 77,101 | 11.3 | % | 230,527 | 252,599 | (8.7 | )% | ||||||||||
Other | — | 1,111 | N/M | — | 3,355 | N/M | ||||||||||||
Total Other | 213,093 | 241,593 | (11.8 | )% | 676,228 | 779,983 | (13.3 | )% | ||||||||||
Total | $ | 1,177,280 | $ | 1,288,237 | (8.6 | )% | $ | 3,419,822 | $ | 3,882,937 | (11.9 | )% | ||||||
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Earnings (loss) from operations is reconciled to earnings (loss) before income taxes as follows:
Thousands of dollars | ||||||||||||||||||||||||
Three Months Ended March 31, 2003 | Donnelley Print Solutions | Logistics Services | Financial Services | Other (1) | Corporate | Consolidated | ||||||||||||||||||
Earnings (loss) from operations | $ | 45,682 |
| $ | 3,543 |
| $ | (6,362 | ) | $ | (9,045 | ) | $ | (6,895 | ) | $ | 26,923 |
| ||||||
Net interest expense |
| (148 | ) |
| (26 | ) |
| — |
|
| (2,436 | ) |
| (10,097 | ) |
| (12,707 | ) | ||||||
Other income (expense): | ||||||||||||||||||||||||
Earnings (loss) from investments |
| (220 | ) |
| — |
|
| — |
|
| (159 | ) |
| 11 |
|
| (368 | ) | ||||||
Foreign currency transaction loss |
| (19 | ) |
| — |
|
| — |
|
| (476 | ) |
| (782 | ) |
| (1,277 | ) | ||||||
Affordable housing write-downs |
| — |
|
| — |
|
| — |
|
| — |
|
| (4,000 | ) |
| (4,000 | ) | ||||||
Other income (expense), net |
| 412 |
|
| — |
|
| (160 | ) |
| 1,258 |
|
| (808 | ) |
| 702 |
| ||||||
Total other income (expense) |
| 173 |
|
| — |
|
| (160 | ) |
| 623 |
|
| (5,579 | ) |
| (4,943 | ) | ||||||
Earnings (loss) before income taxes | $ | 45,707 |
| $ | 3,517 |
| $ | (6,522 | ) | $ | (10,858 | ) | $ | (22,571 | ) | $ | 9,273 |
| ||||||
Thousands of dollars | ||||||||||||||||||||||||
Three Months Ended March 31, 2002 | Donnelley Print Solutions | Logistics Services | Financial Services | Other (1) | Corporate | Consolidated | ||||||||||||||||||
Earnings (loss) from operations | $ | 23,978 |
| $ | 3,043 |
| $ | (12,262 | ) | $ | (14,494 | ) | $ | 10,426 |
| $ | 10,691 |
| ||||||
Net interest expense |
| (64 | ) |
| (1 | ) |
| (3 | ) |
| (2,747 | ) |
| (12,638 | ) |
| (15,453 | ) | ||||||
Other income (expense): | ||||||||||||||||||||||||
Loss from investments |
| (456 | ) |
| — |
|
| — |
|
| (377 | ) |
| (39 | ) |
| (872 | ) | ||||||
Foreign currency transaction loss |
| (9 | ) |
| — |
|
| — |
|
| (2,786 | ) |
| — |
|
| (2,795 | ) | ||||||
Affordable housing write-downs |
| — |
|
| — |
|
| — |
|
| — |
|
| (2,700 | ) |
| (2,700 | ) | ||||||
Corporate-owned life insurance |
| — |
|
| — |
|
| — |
|
| — |
|
| (5,377 | ) |
| (5,377 | ) | ||||||
Other income (expense), net |
| 3,660 |
|
| (61 | ) |
| 191 |
|
| 1,007 |
|
| 56 |
|
| 4,853 |
| ||||||
Total other income (expense) |
| 3,195 |
|
| (61 | ) |
| 191 |
|
| (2,156 | ) |
| (8,060 | ) |
| (6,891 | ) | ||||||
Earnings (loss) before income taxes | $ | 27,109 |
| $ | 2,981 |
| $ | (12,074 | ) | $ | (19,397 | ) | $ | (10,272 | ) | $ | (11,653 | ) | ||||||
(1) | Represents other operating segments of the company, including RRD Direct, International and Other. |
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table shows net sales by end market for the three months ended March 31:
Net Sales | |||||||||
Thousands of dollars | 2003 | 2002 | % Change | ||||||
Magazines, Catalogs and Retail | $ | 362,535 | $ | 386,667 | (6.2 | %) | |||
Book Publishing Services |
| 153,066 |
| 154,670 | (1.0 | %) | |||
Telecommunications |
| 124,101 |
| 143,261 | (13.4 | %) | |||
Premedia Technologies |
| 27,271 |
| 29,736 | (8.3 | %) | |||
Donnelley Print Solutions |
| 666,973 |
| 714,334 | (6.6 | %) | |||
Logistics Services |
| 209,808 |
| 172,079 | 21.9 | % | |||
Financial Services |
| 90,255 |
| 102,875 | (12.3 | %) | |||
RRD Direct |
| 29,146 |
| 33,978 | (14.2 | %) | |||
Other(1) |
| 77,635 |
| 70,384 | 10.3 | % | |||
Total Other |
| 106,781 |
| 104,362 | 2.3 | % | |||
Total | $ | 1,073,817 | $ | 1,093,650 | (1.8 | %) | |||
(1) | Includes International (Latin America, Europe and Asia) and Other. |
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. In several recent federal court decisions involving different corporate taxpayers, the courts disallowed deductions for loans against those taxpayers’ COLI programs. In its audit of the company’s 1990 to 1992 tax returns, the Internal Revenue Service (IRS) disallowed the deductions taken by the company.
On April 1, 2002, the company reached a settlement agreement with the IRS resolving all disputes over the tax deductibility of interest on loans taken out against its COLI programs. As part of the settlement, the company agreed to the disallowance of 80% of its interest deductions on loans related to its COLI programs from 1990 through 1998. PriorAs of March 31, 2002, and prior to the settlement, the company’s exposure related to past COLI interest deductions was $272 million, including interest, after-tax. Based upon the 80% settlement, the company’s exposure for all years iswas approximately $217 million in taxes and interest, after-tax, of which $62 million ($55 million after-tax) was paid in prior years.to 2002. The company has paid approximately $130$150 million of this liability to the IRS in April 2002, with the remainder expected to be paid prior to December 31, 2003.IRS. The remaining amount owed is classified in the accompanying condensed consolidated balance sheet as current income taxes payable.
As part of the settlement with the IRS, the company also surrenderedagreed to surrender approximately 17,000, or 61%, of its outstanding COLI policies to the insurance carriers in April 2002. The IRS agreed to an 80% reduction of the taxable portion of the gain related to the surrender of the COLI policies. The tax at 40% on the remaining 20% gain upon surrender of the policies resulted in additional amounts owed to the IRS of $18 million. In April 2002, the company received $12 million in net cash surrender value related to the policies surrendered.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
As a result of the company’s settlement agreement with the IRS, the company reduced its tax reserves related to COLI to equal the settlement amounts. Accordingly, in the first quarter of 2002, the company recorded a one-time tax benefit of $30 million to reflect the reduction in tax reserves. In addition, the company recorded a nonrecurring pretax charge of $5 million in the first quarter of 2002 related to the surrender of the above COLI policies, which iswas classified in other income (expense), net, in the accompanying condensed consolidated statementstatements of income.
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:
In thousands | Three Months Ended September 30 | Nine Months Ended September 30 | ||||||
2002 | 2001 | 2002 | 2001 | |||||
Average shares outstanding—basic | 113,143 | 115,831 | 113,039 | 117,610 | ||||
Effect of dilutive securities | 1,156 | 1,935 | 1,631 | 1,767 | ||||
Average shares outstanding—diluted | 114,299 | 117,766 | 114,670 | 119,377 | ||||
In thousands, except per share data | Three Months Ended March 31 | |||||
2003 | 2002 | |||||
Average shares outstanding—basic |
| 113,101 |
| 112,894 | ||
Effect of dilutive securities |
| 595 |
| 1,930 | ||
Average shares outstanding—diluted |
| 113,696 |
| 114,824 | ||
Net income | $ | 5,702 | $ | 22,659 | ||
Basic EPS | $ | 0.05 | $ | 0.20 | ||
Diluted EPS |
| 0.05 |
| 0.20 |
Options outstanding to purchase 17 million and 11 million shares of common stock at September 30,March 31, 2003 and 2002, respectively, were not included in the computation of diluted EPSearnings per share because the exercise prices of the options were greater than the average market priceprices of the company’s common shares. The range of exercise prices for these options was between $25.81$20.88 and $46.88 and $28.25$29.24 and $46.88 for the threeat March 31, 2003 and nine months ended September 30, 2002, respectively.
NOTE9.The company has limited transactions that fall under the accounting rules of SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, SFAS No. 138 and SFAS No. 138.149. From time to time, the company uses financial instruments, including interest rate swap agreements and forward exchange and option contracts, to manage exposure to movements in interest rates and exchange rates.
On November 14, 2001, the company issued $225 million in notes bearing interest at afixeda fixed rate of 5%5.0% per annum and maturing on November 15, 2006. In conjunction with this issuance, the company entered into twoa series of pay-floating and pay-fixed interest rate swap agreements. The two agreements have effective datesswaps to take advantage of November 14, 2001 for notional amounts of $100 million each, maturinglower interest rates on November 15, 2006. These agreements effectively converted the notes’ fixed rate to a floating rate of six month LIBOR plus 86.3 basis points. These swaps have been designated as fair value hedges.debt. The fair value of theseinterest ratepay-floating swap agreements, based on quotes from swap dealers, was an asset of approximately $10 million at September 30, 2002 and a liability of approximately $8 million at December 31, 2001. These amounts have been recordedexecuted in the accompanying condensed consolidated balance sheettwo transactions that mature in “Other noncurrent assets” and “Other noncurrent liabilities,” as of September 30, 2002 and December 31, 2001, respectively with offsets recordedNovember 2006. To reduce its exposure to future increases in “Long-term debt.”
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
The following table summarizes the company’s interest rate swaps described above:
Thousands of dollars | Notional Principal(1) | Interest Rates | ||||||||||
Effective Date | Maturity Date | Interest Rate Swaps | Receive | Pay | ||||||||
November 14, 2001 | November 15, 2006 | Receive fixed–pay floating | $ | 100,000 | 5.0% | LIBOR + 0.863% | ||||||
November 14, 2001 | November 15, 2006 | Receive fixed–pay floating | 100,000 | 5.0% | LIBOR + 0.863% | |||||||
May 15, 2002 | November 15, 2002 | Receive floating–pay fixed | 200,000 | LIBOR | 2.268 | % | ||||||
November 15, 2002 | May 15, 2003 | Receive floating–pay fixed | 100,000 | LIBOR | 2.000 | % | ||||||
November 15, 2002 | May 15, 2003 | Receive floating–pay fixed | 100,000 | LIBOR | 1.965 | % |
Thousands of dollars | Notional Principal(1) | Interest Rates | Fair Values | ||||||||||||
Effective Date | Maturity Date | Receive | Pay | ||||||||||||
November 14, 2001 | November 15, 2006 | $ | 100,000 | (4) | 5.0 | % | LIBOR + 0.863% | $ | 5,170 | (2) | |||||
November 14, 2001 | November 15, 2006 |
| 100,000 | (4) | 5.0 | % | LIBOR + 0.863% |
| 5,170 | (2) | |||||
November 15, 2002 | May 15, 2003 |
| 100,000 | (5) | LIBOR |
| 2.000% |
| (301 | )(3) | |||||
November 15, 2002 | May 15, 2003 |
| 100,000 | (5) | LIBOR |
| 1.965% |
| (283 | )(3) | |||||
May 15, 2003 | November 17, 2003 |
| 100,000 | (5) | LIBOR |
| 1.590% |
| (212 | )(3) | |||||
May 15, 2003 | November 17, 2003 |
| 100,000 | (5) | LIBOR |
| 1.650% |
| (235 | )(3) | |||||
November 17, 2003 | May 17, 2004 |
| 100,000 | (5) | LIBOR |
| 1.590% |
| (84 | )(3) | |||||
November 17, 2003 | May 17, 2004 |
| 100,000 | (5) | LIBOR |
| 1.540% |
| (38 | )(3) |
(1) | The notional principal is the amount used for the calculation of interest payments that are exchanged over the life of the swap transaction and is equal to the amount of dollar principal exchanged at maturity, if applicable. |
(2) | Swap is considered a fair value hedge. Accordingly, the fair value is recorded in “Other noncurrent assets” with offsets recorded in “Long-term debt.” |
(3) | Swap does not qualify for hedge accounting. Accordingly, the change in the fair value of this agreement was recorded in “Interest expense” with offsets recorded in “Other accrued liabilities.” |
(4) | Receive fixed-pay floating interest rate swap. |
(5) | Receive floating-pay fixed interest rate swap. |
The net effect of the various interest rate swaps was a reduction in interest expense of $1 million for each of the three months ended March 31, 2003 and 2002.
NOTE 10.The company regularly assesses its manufacturing platforms to assure that they are efficient, flexible and aligned properly with customer needs. Beginning in 2001, theThe company initiated various restructuring plans,actions in 2003, 2002, and 2001, which consisted primarily of the consolidation of plant operations within the Donnelley Print Solutions segment, and the elimination of general and administrative positions company-wide. During the first nine months of 2002, the company announced the closure of its Berea, Ohio facility, along with further workforce reductions primarily within the Donnelley Print Solutions segment.reductions.
During the first quarter of 2002,2003, the company recognized a pretax restructuring and impairment charge of $27$2.6 million, and reduced earnings from operations in the company’s business segments as follows: Donnelley Print Solutions—$23Solutions: $0.2 million; Corporate—$1Financial Services: $0.6 million; Corporate: $1.1 million and Other—$3Other: $0.7 million. This charge included $5 million in expensed as incurred charges for defined exit activities that related to 2001 announced plans (the 2001 plans). The first quarter 2002 restructuring plan (the first quarter plan)2003 charges consisted of workforce reductions and continued consolidations at several of the company’s facilities. The first quarter 2003 pretax charge consisted of the following:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
Thousands of dollars | Reserve balance at January 1, 2003 | First quarter 2003 charges | Cash payments | Pension and postretirement benefits plan adjustment | Non-cash items | Reserve balance at March 31, 2003 | ||||||||||||||||
Employee termination benefits | $ | 14,475 | $ | 1,167 |
| $ | (4,004 | ) | $ | (4,037 | ) | $ | (271 | ) | $ | 7,330 | ||||||
Postretirement plan curtailment |
| — |
| 1,152 |
|
| — |
|
| (1,152 | ) |
| — |
|
| — | ||||||
Exit costs |
| 5,532 |
| (350 | ) |
| (2,081 | ) |
| — |
|
| — |
|
| 3,101 | ||||||
Relocation costs |
| — |
| 716 |
|
| (716 | ) |
| — |
|
| — |
|
| — | ||||||
Asset impairment |
| — |
| (76 | ) |
| — |
|
| — |
|
| 76 |
|
| — | ||||||
Total | $ | 20,007 | $ | 2,609 |
| $ | (6,801 | ) | $ | (5,189 | ) |
| $(195) |
| $ | 10,431 | ||||||
Additional charges related to the 2003 announced actions are expected to be approximately $1 million.
In connection with the plans announced in 2002, the company has ceased print production at its Berea, Ohio facility, and all continuing customer work has been transferred to September 30, 2002:
Thousands of dollars | Reserve balance at January 1, 2002 | First quarter 2002 charges | Second quarter 2002 charges | Third quarter 2002 charges | Cash payments | Pension and post-retirement benefits plan adjustment | Non-cash items | Reserve balance at September 30, 2002 | ||||||||||||||||||||
Employee termination benefits | $ | 25,291 | $ | 14,808 | $ | 3,389 | $ | 7,917 | $ | (18,024 | ) | $ | (20,714 | ) | $ | — | $ | 12,667 | ||||||||||
Postretirement plan curtailment | — | — | — | 8,320 | — | (8,320 | ) | — | — | |||||||||||||||||||
Exit costs | 8,638 | 2,545 | 76 | 739 | (5,846 | ) | — | — | 6,152 | |||||||||||||||||||
Relocation costs | — | 5,035 | 7,087 | 6,477 | (18,599 | ) | — | — | — | |||||||||||||||||||
Asset impairment | — | 4,304 | 5,473 | (744 | ) | — | — | (9,033 | ) | — | ||||||||||||||||||
Total | $ | 33,929 | $ | 26,692 | $ | 16,025 | $ | 22,709 | $ | (42,469 | ) | $ | (29,034 | ) | $ | (9,033 | ) | $ | 18,819 | |||||||||
In connection with the 2001 plans, the company has ceased print production at its St. Petersburg and South Daytona, Florida, Houston, Texas, Des Moines, Iowa, and Old Saybrook, Connecticut and Hamburg Gráfica Editora (Brazil) facilities, and all continuing customer work has been transferred to other company facilities. Additional charges related to the 2001 plans are expected to be minimal, and will primarily relate to relocation costs for employees transferred from closed facilities and equipment transfers.minimal. Of a total of 2,8692,850 planned employee terminations, 2,806all have been completed. The Houston, Texas facility remains open as a sales and service center. The St. Petersburg and South Daytona, Florida, Des Moines, Iowa, and Old Saybrook, Connecticut and Brazilian facilities are currently beingwere considered held for disposal.
As a result of restructuring actions, the company will reduce its workforce by 3,9924,758 employees, or approximately 12.1%14% of its workforce, since 2000. As of September 30, 2002,March 31, 2003, a total of 4,592 terminations have been completed under the restructuring plans, a total of 3,816 terminations have been completed.
The net book value of assets to be disposed of under the restructuring plans as of September 30, 2002 was $19March 31, 2003 of $15 million all of which relaterelated primarily to the Donnelley Print Solutions. Annual depreciation on these assets would have been approximately $4 million.Solutions segment. The assets are comprised primarily of land, plant facilities printing presses and related equipment.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” and reflect the estimated fair value, less costs to sell.
NOTE 11. During the third quarter of 2001, as a result of deteriorating market conditions, the company determined that the carrying value of long-lived assets at one of its subsidiaries in Mexico, Ediciones Eclipse S.A. de C.V. (Eclipse), was impaired based on estimated future undiscounted cash flows. Accordingly, the company recorded a non-cash pretax impairment charge of $12 million ($7 million after-tax, or $0.06 per diluted share) in the third quarter of 2001 to writedown the carrying value of Eclipse’s long-lived assets to fair value. Of the total pretax charge, $10 million related to the writedown of goodwill and $2 million to the writedown of property, plant and equipment.
Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||
Thousands of dollars, except per share data | 2002 | 2001 | 2002 | 2001 | ||||||||
Net Income: | ||||||||||||
Reported net income | $ | 47,742 | $ | 42,042 | $ | 94,178 | $ | 62,694 | ||||
Goodwill amortization, net of tax | — | 3,294 | — | 10,193 | ||||||||
Adjusted net income | $ | 47,742 | $ | 45,336 | $ | 94,178 | $ | 72,887 | ||||
Basic Earnings Per Share: | ||||||||||||
Reported basic earnings | $ | 0.42 | $ | 0.36 | $ | 0.83 | $ | 0.53 | ||||
Goodwill amortization, net of tax | — | 0.03 | — | 0.09 | ||||||||
Adjusted basic earnings | $ | 0.42 | $ | 0.39 | $ | 0.83 | $ | 0.62 | ||||
Diluted Earnings Per Share: | ||||||||||||
Reported diluted earnings | $ | 0.42 | $ | 0.36 | $ | 0.82 | $ | 0.53 | ||||
Goodwill amortization, net of tax | — | 0.03 | — | 0.09 | ||||||||
Adjusted diluted earnings | $ | 0.42 | $ | 0.39 | $ | 0.82 | $ | 0.62 | ||||
Thousands of dollars | Net Book Value at January 1, 2002 | Foreign Exchange/Other | Disposition | Net Book Value at September 30, 2002 | ||||||||||
Donnelley Print Solutions | $ | 80,552 | $ | — | $ | — | $ | 80,552 | ||||||
Logistics Services | 150,344 | — | — | 150,344 | ||||||||||
Other(1) | 81,717 | (3,787 | ) | (1,800 | ) | 76,130 | ||||||||
$ | 312,613 | $ | (3,787 | ) | $ | (1,800 | ) | $ | 307,026 | |||||
Thousands of dollars | Net Book Value at January 1, 2003 | Foreign Exchange/Other | Net Book Value at March 31, 2003 | |||||||
Donnelley Print Solutions | $ | 80,552 | $ | — |
| $ | 80,552 | |||
Logistics Services |
| 149,312 |
| 27 |
|
| 149,339 | |||
Financial Services |
| 23,495 |
| — |
|
| 23,495 | |||
Other(1) |
| 54,815 |
| (1,286 | ) |
| 53,529 | |||
$ | 308,174 | $ | (1,259 | ) | $ | 306,915 | ||||
(1) | Represents other operating segments of the company, including |
Other intangible assets primarily consistsconsist of the costs of acquiring print contracts and volume guarantees that are amortized primarily as a reduction to net sales over the periods in which benefits will be realized.
The aggregate amortization expense for intangible assets subject to amortization was $6$5 million and $7 million for the three months ended September 30,March 31, 2003 and 2002, respectively.
NOTE 12. On March 6, 2003, the company acquired certain net assets of Momentum Logistics, Inc. (MLI), a Florida-based provider of package distribution services, for approximately $17 million in cash. MLI operates sortation facilities and 2001, respectively,a dedicated fleet of vehicles to provide business-to-business and $20 millionbusiness-to-consumer package distribution services. The allocation of the purchase price is preliminary pending completion of valuations of the assets acquired by independent valuation firms and $23 million forfinal determination of the nine months ended September 30, 2002 and 2001, respectively.
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
NOTE 13. As permitted under SFAS No. 123,Accounting for Stock-Based Compensation, the company accounts for stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations. Stock options granted during the three months ended March 31, 2003 and 2002 were exercisable at prices equal to the fair market value of the company’s common stock on the dates the options were granted; accordingly, no compensation expense has been recognized for the stock options granted. Had compensation cost been determined using the fair value recognition provisions of SFAS No. 123 and related amendments, the company’s net income and basic and diluted earnings per share would have been as follows:
Three Months Ended March 31, | ||||||||
Thousands of dollars, except per share data | 2003 | 2002 | ||||||
Net income, as reported | $ | 5,702 |
| $ | 22,659 |
| ||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
| (2,622 | ) |
| (2,609 | ) | ||
Pro forma net income | $ | 3,080 |
| $ | 20,050 |
| ||
Earnings per share: | ||||||||
Basic—as reported | $ | 0.05 |
| $ | 0.20 |
| ||
Basic—pro forma |
| 0.03 |
|
| 0.18 |
| ||
Diluted—as reported |
| 0.05 |
|
| 0.20 |
| ||
Diluted—pro forma |
| 0.03 |
|
| 0.17 |
|
The fair value of each option granted in the respective period is estimated at the date of grant using the Black-Scholes option-pricing model.
NOTE 14.Effective January 1, 2002,2003, the company adopted SFAS No. 144,146,Accounting for Impairment of Long-Lived AssetsCosts Associated with Exit or Disposal Activities, which replaces SFASrescinds Emerging Issues Task Force (EITF) Issue No. 121,94-3,Accounting“Liability Recognition for the Impairment of Long-Lived AssetsCertain Employee Termination Benefits and Other Costs to be Disposed Of.Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS No. 144 establishes146 requires companies to recognize costs associated with exit or disposal activities when they are incurred, rather than at the date of a single accounting model for thecommitment to an exit or disposal plan. Examples of long-lived assetscosts covered by salethis statement include lease termination costs and resolves significant implementation issues related to SFAS No. 121, including defining when an asset can be considered held-for-sale and the measurement of future cash flows. The adoptioncertain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity. Adoption of this standardstatement did not have a material impact on the company’s financial position, results of operations or cash flows for the three or nine months ended September 30, 2002.flows.
NOTE 14.In June 2002,January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) No. 46“Consolidation of Variable Interest Entities, An Interpretation of APB No. 51.” FIN 46 provides guidance on the identification of entities for which control is achieved through means other than through voting rights (variable interest entities or VIE) and how to determine when and which business enterprises should consolidate the VIE. This new model for consolidation applies to entities (1) where the equity investors (if any) do not have a controlling financial interest or (2) whose equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46
R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
applies immediately to VIEs created after January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. The company is required to adopt FIN 46 in the third quarter of 2003 for arrangements entered into prior to January 31, 2003. The company’s risk of loss related to equity investments, including investments in affordable housing, is generally limited to the carrying value of these investments, which was approximately $120 million at March 31, 2003. The company is evaluating its investments to determine which investment, if any, would be impacted by the adoption of FIN 46.
As of December 31, 2002, the company adopted the disclosure requirement of SFAS No. 146,148,Accounting for Costs Associated with Exit or Disposal ActivitiesStock Based Compensation—Transition and Disclosure.. This statement requiresamends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. As of March 31, 2003, the company has elected not to change to the fair value based method of accounting for stock-based employee compensation. The company accounts for employee stock options under APB No. 25, under which the company did not recognize any compensation cost for the three months ended March 31, 2003 and 2002. See Note 13 to the condensed consolidated financial statements for the related disclosures required under SFAS No. 148.
In November 2002, the EITF reached a consensus on EITF 00-21,“Accounting for Revenue Arrangements with Multiple Deliverables.” EITF 00-21 establishes criteria for whether revenue on a deliverable can be recognized separately from other deliverables in a multiple deliverable arrangement. The criteria considers whether the delivered item has stand-alone value to the customer, whether the fair value of the delivered item can be reliably determined and the right of return for the delivered item. EITF 00-21 is effective for revenue agreements entered into for fiscal periods beginning after June 15, 2003 with early adoption permitted. The company is currently evaluating the impact of EITF 00-21 on its financial position, results of operations and cash flows.
In November 2002, the FASB issued FIN 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” The Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for costs associated with an exit or disposal activity shall be recognized and measured initially atthe fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in the period in which the liability is incurred, rather than at the date ofits interim and annual financial statements. The initial recognition and initial measurement provisions apply on a commitmentprospective basis to the exitguarantees issued or disposal plan. This statement will be applied prospectively to exit or disposal activities that are initiated by the companymodified after December 31, 2002.
RR Donnelley & Sons Company (NYSE:DNY) provides comprehensive,prepares, produces and delivers integrated communications services that efficientlyacross multiple channels for content owners such as publishers, merchandisers and effectively produce, managetelecommunications companies, as well as capital markets and deliver our customers’ content, regardless of the communications medium.diversified financial services companies. While our print capabilities remain the foundation of the company, our recent focus on expanding theour 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 |
· | 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 quickly produce large printing jobs with identical specifications. We also are able to version printed content to reach targeted audiences. |
· | Distribution—to deliver our customers’ words and images efficiently and reliably through print or the Internet. |
Our 138-year139-year history as a printing industry leader positions us well for the future. We expect print advertising to remain among the most cost-effective ways for our customers to deliver their messages and generate revenue as they use words and images to inform, educate, entertain and sell to their audiences.
We believe that print will remain integral to successful marketing given its unique capabilities, such as portability and high-quality graphics that cannot be duplicated by other communications methods. We also believe that the nature of print will continue to evolve. The ability of print to be targeted, timely, flexible and integrated with other communications media will become even more critical.
End-MarketEnd Market Descriptions
We operate primarily in the commercial print portion of the printing industry, with related service offerings designed to offer customers complete solutions for communicating their messages to targeted audiences. While our manufacturing plants, financial service centers and sales offices are located throughout the U.S. and selected international markets, the supporting technologies and knowledge base are common. Our locations 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 distribution platform.platforms. As a result, most plants produce work for customers in two or three of our end-markets.
The following describes the end-marketsend markets we serve:
Magazines, Catalogs and Retail R.R.RR Donnelley is a leader in the North American magazine, catalog and retail advertising insert markets. These markets are characterized by demand for large, cost-effective print runs with opportunity for differentiation among competitors throughservices such as Premedia Technologies and Donnelley Logistics. Our U.S. customers include the majority of the top 10magazine10 magazine titles and a majority of the largest consumer catalog companies and retailers. Contracts typically span from three to five years.
We are also 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 15,000 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.
Telecommunications R.R.RR 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,(SBC, Verizon and Qwest), independent directory publishers such as Yellow Book,Feist, RHD, White Directories and Yell USA and leading international telecommunications providers such as Yell KPN and Shanghai Telephone. Directory contracts typically span five to 12 years, with our current major contracts expiring between 20042006 and 2013.2015.
Book Publishing Services R.R.RR Donnelley, the leader in the North American book market, serves the consumer, religious, educational and specialty book segments. We are a key services provider for the majority of the top 10 U.S. book publishers and we typically print more than 50% ofThe New York Times’adult best-seller titles. We also print approximately one-third of all textbooks used in classrooms in the U.S.
PremediaTechnologies R.R.RR Donnelley’s Premedia Technologies business partners with customers to effectively create, manage, prepare and distribute customer content. We offer services in both conventional and digital photography, creative and color services, page production, ad management, facilities management and content management. Integrating these core competencies enables us to help customers efficiently, consistently and successfully deliver their messages across multiple channels, including print and the Internet. We leverage our experience in content production and workflow optimization to link our customers’ creative processes with today’s technologies. Facilities located in key markets provide close customer contact with nationwide scaleup capabilities. Premedia Technologies’ services are used by leading-edge companies in the advertising, agency, catalog, corporate, magazine, retail and telecommunications markets.
Financial Services R.R.RR Donnelley Financial, a leader in the U.S. and international financial services markets, supports the communications needs of corporations and their investment banks and law firms, as those corporations access the global capital markets. We also are a leading provider of customized
communications solutions for investment management, banking, insurance and 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, we produced 40% of the top 25deals, including initial public offerings in 2001, as well as three of the top five insurance demutualizations since 2000, including the largest in 2001. Additionally, we are a leading provider of mutual fund compliance communications.and mergers. 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 filingsfilings. In addition, in 2002, we introduced NET.Filer, an online self-service application designed to help clients meet the accelerated Form 4 filing requirements mandated by the U.S. Securities and have integrated database management with content assembly, digital output and multiple-media delivery.
Our customized communications solutions business enables investment management, banking, insurance and managed care clients to manage and produce their stakeholder communications, from compliance documents to marketing materials, more efficiently. We 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. These include services which help our customers leverage the power of the Internet in communicating with their audiences. 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.
RRD Direct RRD Direct offers expertise in a wide range of direct marketing print and related services.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.
International We have extended our core competencies for high quality print and related services into non-U.S. geographic markets. These markets tend to be emerging, with favorable demographic trends such as rising education levels and increasing disposable income. Our international operations in Latin America, PolandEurope and China,Asia, where we produce magazines,books and telephone directories, are reported as “International.”Other. Financial Services’ international revenue is included in “FinancialFinancial Services.” Directory revenues from England are included in “Telecommunications.”Telecommunications.
Donnelley Logistics continues to focus on growing the package delivery part of its operation, which complements its long-standing core competency of print logistics. We leverage our national network as well as the USPS infrastructure to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The U.S. Securities and Exchange Commission has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of its financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. For information on accounting policies, refer to the “Summary of Significant Accounting Policies” footnote on page F-6 in the 2001 Annual Report on Form 10-K. Although we believe that our estimates and assumptions are reasonable, they are based upon information available when they are made. Actual results may differ significantly from these estimates under different assumptions or conditions.
In addition to Donnelley Logistics, which includes delivery ofdelivering packages and printed material, the company recognizes revenue upon completionDonnelley Logistics also provides package returns services and expedited distribution of the deliverytime-sensitive and secure material (expedited services). Together, these services it provides.
The following is a discussion of the results of operations for the thirdfirst quarter and first nine months of 20022003 compared with the thirdfirst quarter and first nine months of 2001,2002, and a discussion of the changes in financial condition during the first ninethree months of 2002.
Beginning January 1, 2003, the company revised its segment reporting to reflect RR Donnelley Financial (Financial Services) as a separate business segment. The company’s Financial Services operations were previously reported within the Other business segment.
Items Affecting Comparability of the Third Quarter of2003 with 2002 with the Third Quarter of 2001
The following table summarizes significant items affectaffecting comparability of the condensed consolidated statements of income and segment operating results:
Three Months Ended March 31 | ||||||||||||||||||||||||
2003 | 2002 | |||||||||||||||||||||||
Earnings before Income Taxes | Net Income | Per Diluted Share | Earnings before Income Taxes | Net Income | Per Diluted Share | |||||||||||||||||||
Dollars in thousands, except per-share data | ||||||||||||||||||||||||
As reported | $ | 9,273 |
| $ | 5,702 |
| $ | 0.05 |
| $ | (11,653 | ) | $ | 22,659 |
| $ | 0.20 |
| ||||||
Included in earnings from operations: | ||||||||||||||||||||||||
Restructuring and impairment charges | $ | (2,609 | ) | $ | (1,618 | ) | $ | (0.01 | ) | $ | (26,692 | ) | $ | (16,816 | ) | $ | (0.14 | ) | ||||||
By-product revenues |
| 10,962 |
|
| 6,796 |
|
| 0.06 |
|
| 8,714 |
|
| 5,490 |
|
| 0.05 |
| ||||||
Gain on sale of assets |
| 1,945 |
|
| 1,206 |
|
| 0.01 |
|
| — |
|
| — |
|
| — |
| ||||||
Insurance recovery related to 9/11 |
| 2,047 |
|
| 1,269 |
|
| 0.01 |
|
| — |
|
| — |
|
| — |
| ||||||
Provision for doubtful accounts |
| (9,928 | ) |
| (6,155 | ) |
| (0.05 | ) |
| (2,959 | ) |
| (1,864 | ) |
| (0.02 | ) | ||||||
Pension and postretirement benefit income |
| 1,260 |
|
| 781 |
|
| — |
|
| 5,718 |
|
| 3,602 |
|
| 0.03 |
| ||||||
| 3,677 |
|
| 2,279 |
|
| 0.02 |
|
| (15,219 | ) |
| (9,588 | ) |
| (0.08 | ) | |||||||
Included in other income (expense): | ||||||||||||||||||||||||
Affordable housing amortization |
| (4,000 | ) |
| (2,480 | ) |
| (0.02 | ) |
| (2,700 | ) |
| (1,701 | ) |
| (0.01 | ) | ||||||
COLI-related expenses upon policy surrender |
| — |
|
| — |
|
| — |
|
| (4,883 | ) |
| (3,076 | ) |
| (0.03 | ) | ||||||
Included in tax benefit (provision): | ||||||||||||||||||||||||
Reversal of excess COLI tax reserves |
| — |
|
| — |
|
| — |
|
| — |
|
| 30,000 |
|
| 0.26 |
| ||||||
Total items affecting comparability | $ | (323 | ) | $ | (201 | ) | $ | — |
| $ | (22,802 | ) | $ | 15,635 |
| $ | 0.14 |
| ||||||
Unusual items—restructuringRestructuring and impairment: ThirdOperating results for the first quarter of 2003 and 2002 included pretaxwere affected by the following restructuring and impairment charges of $23 million ($14 million after-tax, or $0.12 per diluted share). During the third quarter of 2002, we incurred certain costs associated with defined exit activities from previously announced restructuring plans, as well as several additional workforce reductions. Included initems:
· | 2003 included pretax restructuring and impairment charges of $2.6 million ($1.6 million after-tax, or $0.01 per diluted share). The 2003 pretax charge included a $1 million curtailment loss on our postretirement benefit plans, costs associated with newly-announced consolidations and workforce reductions, and costs associated with defined exit activities from previously announced restructuring plans. Restructuring and impairment charges for 2003 by segment were as follows: Donnelley Print Solutions: $0.2 million; Financial Services: $0.6 million; Corporate: $1.1 million and Other: $0.7 million. |
· | 2002 included pretax restructuring and impairment charges of $27 million ($17 million after-tax, or $0.14 per diluted share). The 2002 pretax charge included $15 million to close our Berea, Ohio facility as well as additional workforce reductions at several other facilities. Restructuring and impairment charges for 2002 by segment were as follows: Donnelley Print Solutions: $23 million; Corporate: $1 million and Other: $3 million. |
By-product revenues: 2003 included pretax income of $11 million for by-product revenues compared with $9 million in 2002. By-product revenues are recorded as a reduction in our cost of materials, the majority of which relates to the Donnelley Print Solutions segment.
Gain on sale of assets: 2003 included a $2 million pretax gain from the sale of our Casa Grande, Arizona manufacturing facility, included in the third quarter was an $8 million non-cash provisionDonnelley Print Solutions segment.
Insurance recovery related to 9/11:2003 included a $2 million pretax gain from the curtailment loss on ourcollection of insurance proceeds from claims related to September 11th, included in the Financial Services segment.
Provision for doubtful accounts:2003 included a $10 million pretax provision for bad debt compared with a $3 million provision in 2002. The increase between years was driven by the bankruptcy filing of a major domestic catalog customer and a financially insolvent directory publishing customer in Latin America.
Pension and postretirement benefit plans. Third quarter 2002 pretax restructuring and impairment charges by segment were as follows: Donnelley Print Solutions: $7 million; Corporate: $13 million and Other: $3 million.
Affordable housing write-downs: 2003 included a pretax charge of $20$4 million ($12 million after-tax, or $0.10 per diluted share). The costs include a reduction into write down the carrying value of long-lived assets at oneour investments in affordable housing compared with a pretax charge of $3 million in 2002. The write-downs reflected declines in the underlying estimated fair value of our subsidiariesaffordable housing investments and were included in Mexico, Ediciones Eclipse S.A. de C.V. (Eclipse). The non-cash pretax impairment charge was $12the Corporate segment.
COLI-related expenses upon policy surrender: 2002 included a $5 million ($7 million after-tax, or $0.06 per diluted share) to writedown the carrying value of Eclipse’s long-lived assets to fair value. Of the total pretax charge $10 millionfor expenses related to the writedownsurrender of goodwill and $2 million tocertain corporate-owned life insurance (COLI) policies in conjunction with our settlement with the writedown of property, plant and equipment. The remaining charges in the quarter related to certain costs associated with defined exit activities from previously announced restructuring plans, as well as additional workforce reductions. Third quarter 2001 pretax restructuring and impairment charges by segment were as follows: Donnelley Print Solutions: $8 million and Other: $12 million.
Reversal of excess COLI tax reserves: 2002 included an after-tax benefit of $30 million from the “Restructuring and Impairment” footnote on page F-9 inreversal of excess tax reserves related to our settlement with the 2001 Annual Report on Form 10-K.
Consolidated Results—First Quarter 2003 Compared with First Quarter 2002
Net sales for the thirdfirst quarter of 2001 was as follows: Donnelley Print Solutions: $1 million; Logistics Services: $2 million and Other: $1 million.
Three Months Ended September 30 | ||||||||||||||||||||||||
Thousands of dollars, except per share data | 2002 | 2001 | ||||||||||||||||||||||
Earnings before Income Taxes | Net Income | Per Diluted Share | Earnings before Income Taxes | Net Income | Per Diluted Share | |||||||||||||||||||
Restructuring and impairment charges | $ | (22,709 | ) | $ | (13,627 | ) | $ | (0.12 | ) | $ | (19,860 | ) | $ | (12,214 | ) | $ | (0.10 | ) | ||||||
Impact of prior year goodwill amortization | — | — | — | (4,350 | ) | (3,294 | ) | (0.03 | ) | |||||||||||||||
Total | $ | (22,709 | ) | $ | (13,627 | ) | $ | (0.12 | ) | $ | (24,210 | ) | $ | (15,508 | ) | $ | (0.13 | ) | ||||||
For our print-related businesses, value-added revenue represents net sales less the cost of 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 related services; other customers furnish their own paper. The value of customer-furnished paper is not
reflected in our financial results. For our Logistics Services segment, value-added revenue represents
Consolidated value-added revenue decreased $55$14 million, or 7.5%2.1%, to $684$618 million compared with $740$632 million in the thirdfirst quarter of 2001,2002, primarily driven by the decline in value-added revenue of the Donnelley Print Solutions segment of 6.6%.and Financial Services. Donnelley Print Solutions’ percentage decline in value-added revenue was less than the decline in net sales, primarily due to higher customer-furnished paper during 2002.and higher by-product revenues and purchase discounts in 2003. Value-added revenue of our Financial Services segment declined 13.4% between years, primarily due to a decline in domestic capital markets activity and lower volumes from customized communications solutions. Value-added revenue of our Logistics Services segment increased 6.6%17.2% between years, primarily due to a 16.7%26.2% increase in value-added revenue for package logistics driven by higher postage discounts due to deeper penetration of the postal system, partially offset by a 5.4% decrease within the print logistics business. In addition,logistics. An acquisition contributed an incremental $3 million in value-added revenue for package logistics between years.
Value-added revenue is also affected by the price of by-product paper we sell. Income from the sale of by-products is recorded as a reduction in cost of materials. During the thirdfirst quarter of 2002,2003, we recognized a reduction in cost of materials of $14$11 million from by-product revenues, compared with $10$9 million a year ago.
Gross profit as a percentage of net sales was 20.6%15.7% in the thirdfirst quarter of 20022003 compared with 18.4%15.4% in the thirdfirst quarter of 2001. Gross profit for our2002. The improvement was driven primarily by higher margins within Donnelley Print Solutions segmentand Financial Services. Donnelley Print Solutions’ gross profit margin was favorable toaffected positively in the prior year due tofirst quarter of 2003 by higher by-product revenues and purchase discounts, the impact of restructuring savings and productivity initiatives as well as gainsand a $2 million gain on the sale of a facility in York, England ($6 million)closed facility. Despite lower net sales between years, Financial Services’ gross profit margin increased for the first quarter of 2003, as a result of cost reduction initiatives, restructuring savings and miscellaneous equipment ($1 million). Grossa $2 million gain from an insurance settlement related to September 11th. Logistics Services’ gross profit for our Logistics Services segment was basically flat as comparedmargin decreased between years, primarily due to the prior year quarter after excluding the impact of the elimination of goodwill amortization in 2002.
Selling and administrative expenses decreased $1increased $8 million, or 0.9%6.3%, to $134$139 million compared with $135$131 million in the thirdfirst quarter of 2001.2002. This decreaseincrease was driven by reductionsan additional $7 million provision for doubtful accounts, of which $5 million related to a 2003 bankruptcy filing by a major domestic catalog customer, and $2 million for a financially insolvent directory publishing customer in volume-based incentives (sales commissions), savings from restructuring actions and lower spending on complementary businesses, partially offset by higher management incentive compensation expense and lower benefit plan earnings.Latin America. Selling and administrative expenses as a percentage of net sales was 11.4%12.9% in the thirdfirst quarter of 20022003 compared with 10.5%11.9% in the thirdfirst quarter of 2001.
Net interest expense decreased 10.1%17.8% to $17$13 million in the thirdfirst quarter of 2002,2003, compared with $19$15 million in the thirdfirst quarter of 2001,2002, primarily due to lower effective interest rates on outstanding debt.debt and lower average outstanding debt levels. Other income,expense, net, in the thirdfirst quarter of 20022003 was $6$5 million compared with $5$7 million in the thirdfirst quarter of 2001. Third2002. First quarter 20022003 other income,expense, net, included an increase of $4 million in earnings from equity-based investments between years,lower COLI expenses ($5 million) (see Note 7 to the condensed consolidated financial statements for additional information) and lower foreign currency transaction losses ($2 million), partially offset by $3 million ofhigher affordable housing amortization ($1 million) and lower miscellaneous income.
On April 1, 2002, we reached a settlement agreement with the IRS regarding our deductions for interest on loans borrowed against COLI programs (see Note 7 to the condensed consolidated financial statements for additional information). We had previously established reserves for the COLI-related
exposure, and as the settlement was less than the established reserves, we recorded a one-time tax benefit ($30 million after-tax; $0.26 per diluted share) during the first quarter of 2002.
Earnings before income taxes in the thirdfirst quarter of 20022003 were $75$9 million compared with $68a loss of $12 million in 2001.2002. Earnings before income taxes included $23$3 million and $20$27 million in restructuring and impairment charges for the three months ended September 30,March 31, 2003 and 2002, and 2001, respectively. Net income was $48 million, up $6 million, down $17 million from $42$23 million in 2001. Diluted earnings2002. 2002 included a one-time tax benefit ($30 million after-tax; $0.26 per sharediluted share) for the reversal of $0.42 increased $0.06 from $0.36 in 2001.COLI-related tax reserves. The effective tax rate for the thirdfirst quarter of 20022003 was 36.1%38.5% compared with 38.5%37.0% in 2001.2002, excluding the one-time tax benefit described above. The 20022003 effective tax rate is lowerhigher than 20012002 primarily due to the company’s settlement with the IRS surrounding the company’s COLI program (see Note 7 to the condensed consolidated financial statements).
Net Sales | Value-Added Revenue | |||||||||||||||||
Thousands of dollars | 2002 | 2001 | % Change | 2002 | 2001 | % Change | ||||||||||||
Magazines, Catalogs and Retail | $ | 387,643 | $ | 446,579 | (13.2% | ) | $ | 245,113 | $ | 276,686 | (11.4% | ) | ||||||
Book Publishing Services | 193,882 | 199,505 | (2.8% | ) | 137,003 | 136,909 | 0.1% | |||||||||||
Telecommunications | 158,756 | 174,162 | (8.8% | ) | 81,158 | 79,116 | 2.6% | |||||||||||
Premedia Technologies | 31,010 | 36,339 | (14.7% | ) | 31,016 | 36,339 | (14.6% | ) | ||||||||||
Donnelley Print Solutions | $ | 771,291 | $ | 856,585 | (10.0% | ) | $ | 494,290 | $ | 529,050 | (6.6% | ) | ||||||
Logistics Services | 192,896 | 190,059 | 1.5% | 45,089 | 42,307 | 6.6% | ||||||||||||
Financial Services | 93,482 | 117,233 | (20.3% | ) | 78,393 | 98,819 | (20.7% | ) | ||||||||||
RRD Direct | 33,828 | 46,148 | (26.7% | ) | 20,586 | 25,355 | (18.8% | ) | ||||||||||
International(1) | 85,783 | 77,101 | 11.3% | 45,983 | 40,569 | 13.3% | ||||||||||||
Other | — | 1,111 | N/M | — | 3,400 | N/M | ||||||||||||
Total Other | 213,093 | 241,593 | (11.8% | ) | 144,962 | 168,143 | (13.8% | ) | ||||||||||
Total | $ | 1,177,280 | $ | 1,288,237 | (8.6% | ) | $ | 684,341 | $ | 739,500 | (7.5% | ) | ||||||
Operating Results by Business Segment—ThirdFirst Quarter 20022003 Compared with ThirdFirst Quarter 20012002
As discussed more fully in Note 6 to the condensed consolidated financial statements, we have twothree reportable segments: Donnelley Print Solutions, Logistics Services and LogisticsFinancial Services.
Operating results by business segment in the first quarter of 2003 compared with the first quarter of 2002 are as follows:
Three months Ended March 31
Net Sales | Value-Added Revenue | |||||||||||||||||
Thousands of dollars | 2003 | 2002 | % Change | 2003 | 2002 | % Change | ||||||||||||
Magazines, Catalogs and Retail | $ | 362,535 | $ | 386,667 | (6.2 | %) | $ | 229,583 | $ | 241,128 | (4.8 | %) | ||||||
Book Publishing Services |
| 153,066 |
| 154,670 | (1.0 | %) |
| 110,861 |
| 111,534 | (0.6 | %) | ||||||
Telecommunications |
| 124,101 |
| 143,261 | (13.4 | %) |
| 64,257 |
| 64,107 | 0.2 | % | ||||||
Premedia Technologies |
| 27,271 |
| 29,736 | (8.3 | %) |
| 27,272 |
| 29,736 | (8.3 | %) | ||||||
Donnelley Print Solutions |
| 666,973 |
| 714,334 | (6.6 | %) |
| 431,973 |
| 446,505 | (3.3 | %) | ||||||
Logistics Services |
| 209,808 |
| 172,079 | 21.9 | % |
| 51,556 |
| 43,984 | 17.2 | % | ||||||
Financial Services |
| 90,255 |
| 102,875 | (12.3 | %) |
| 75,277 |
| 86,960 | (13.4 | %) | ||||||
RRD Direct |
| 29,146 |
| 33,978 | (14.2 | %) |
| 17,782 |
| 18,824 | (5.5 | %) | ||||||
Other(1) |
| 77,635 |
| 70,384 | 10.3 | % |
| 41,482 |
| 35,272 | 17.6 | % | ||||||
Total Other |
| 106,781 |
| 104,362 | 2.3 | % |
| 59,264 |
| 54,096 | 9.6 | % | ||||||
Total | $ | 1,073,817 | $ | 1,093,650 | (1.8 | %) | $ | 618,070 | $ | 631,545 | (2.1 | %) | ||||||
Cost of materials and transportation |
| 455,747 |
| 462,105 | ||||||||||||||
Value-added revenue | $ | 618,070 | $ | 631,545 | ||||||||||||||
(1) | Includes International (Latin America, Europe and Asia) and Other. |
Net SalesDonnelley Print Solutions
The following table summarizes significant items affecting comparability within the Donnelley Print Solutions segment:
Quarter Ended March 31 | ||||||||
2003 | 2002 | |||||||
Earnings before | ||||||||
Thousands of dollars | ||||||||
As reported | $ | 45,707 |
| $ | 27,109 |
| ||
Included in earnings from operations: | ||||||||
Restructuring and impairment charges | $ | (169 | ) | $ | (23,122 | ) | ||
By-product revenues |
| 9,502 |
|
| 7,487 |
| ||
Gain on sale of assets |
| 1,800 |
|
| — |
| ||
Total items affecting comparability | $ | 11,133 |
| $ | (15,635 | ) | ||
Net sales for the Donnelley Print Solutions segment decreased $85$47 million in the thirdfirst quarter of 2002,2003, or 10.0%6.6%, from a year ago. ThirdThe economic slowdown since 2000 has generated excess industry capacity from reduced volume levels and higher customer bankruptcies resulting in increased competition and pricing pressures. First quarter 2003 net sales for Magazines, Catalogs and Retail decreased 13.2%6.2% between years, which reflected volume decreases andprimarily price deterioration across all major markets. The continued economic slowdown during 2002 hasand a mix shift to lower-priced work. Pricing pressures continue to impact the industry and have resulted in lower volume and more customer bankruptcies within our Catalog and Retail markets, and lower advertising pages in both trade and consumer magazines.contract prices that continue to cycle through. The net sales decline between years in Premedia Technologies is driven by these same factors. Depressed volumes in these markets are driving increased competition and pricing pressures, and certain customer work which has been lost due to bankruptcy or other factors has been replaced with lower priced work. Book Publishing Services’ thirdfirst quarter net sales decreased 2.8%1.0% between years primarily due to decreasesa shift in timing of work for the education religious, and specialty markets and more customer-furnished paper, partially offset by increases inmarket to the consumer market. Thirdsecond quarter 2002of 2003. First quarter 2003 net sales for Telecommunications were down 8.8% between years due to a shift to more customer-furnished paper.
First quarter value-added revenue for the Donnelley Print Solutions segment decreased $35$15 million, or 6.6%3.3%, from a year ago primarily due to the volumesales declines noted above, partially offset by higher by-product revenues, higher purchase discounts and price deterioration noted above.improved material yield. Value-added revenue for Magazines, Catalogs and Retail and Premedia Technologies declined 11.4% and 14.6%, respectively,4.8% between years, consistent withdue to the declines in net sales partially offset by higher by-product revenues and purchase discounts. Value-added revenue for Book Publishing Services declined 0.6% from 2002, driven by the decline in net sales. Value-added revenue for Book Publishing Services was flat compared to 2001. Value-added revenue for Telecommunications increased 2.6%0.2% between years because of improved material yield. This increase occurred despite an 8.8%a 13.4% decline in net sales, primarily due to higher volumes and more customer-furnished paper.
First quarter earnings from operations for the Donnelley Print Solutions segment increased $10$22 million, or 10.2% between years.91.7%, to $46 million in 2003. Earnings from operations for the three months ended March 31, 2002 included $7 million and $8$23 million in restructuring and impairment chargescharges. Earnings from operations for the three months ended September 30, 2002 and 2001, respectively. In addition, earnings from operationsMarch 31, 2003 included a $2 million gain on the sale of a closed facility in York, England of $6 million in the third quarter of 2002.Casa Grande, Arizona. Net sales continue to be negatively affected by the slowdown in the U.S. economy, particularly in Magazines, Catalogs and Retail. The portion of the net sales decline driven by the mix change did not impact overall profitability due to lower manufacturing costs per unit. The impact of our productivity initiatives, as well as savings from actions we have taken to restructure our operations, have largely offset the effects of volume declines and price erosion on earnings from operations.
Logistics Services
The following table summarizes significant items affecting comparability within the Logistics Services segment:
Quarter Ended March 31 | ||||||||
2003 | 2002 | |||||||
Earnings before | ||||||||
Thousands of dollars | ||||||||
As reported | $ | 3,517 |
| $ | 2,981 |
| ||
Included in earnings from operations: | ||||||||
Restructuring and impairment charges | $ | — |
| $ | (24 | ) | ||
Acquisitions |
| (246 | ) |
| — |
| ||
Total items affecting comparability | $ | (246 | ) | $ | (24 | ) | ||
Net sales for the Logistics Services segment increased $38 million, or 21.9% from a year ago. First quarter net sales for the package logistics business were $2up 31.9% between years. The acquisition of Momentum Logistics, Inc. (MLI) in March 2003 contributed an incremental $5 million in net sales for package logistics between years. Excluding the acquisition of MLI, net sales of package logistics rose 27.3% between years, which included a mix change toward lighter weight, lower priced packages and postal rate increases, which were passed on to customers. First quarter net sales for the print logistics business were up 7.0% between years, driven by increased volumes from third parties.
First quarter value-added revenue for the Logistics Services segment increased $8 million, or 17.2%, compared with a 21.9% increase in net sales. Value-added revenue for package logistics increased 26.2% between years. The acquisition of MLI contributed an incremental $3 million in value-added revenue for package logistics between years. Excluding the acquisition of MLI, value-added revenue for package logistics rose 13.8% between years. The change from 2002 was driven by volume increases and higher postage discounts due to deeper penetration of the postal system, which were partially offset by higher per unit transportation costs due to price increases from regional carriers and higher fuel costs. Value-added revenue for print logistics was up 3.9% between years, due to the volume increases noted above.
First quarter 2003 earnings from operations were $4 million, an increase of $2 million16.4% from 2001.2002. The increase between years was driven by higher value-added revenues from both our package and print logistics businessbusinesses, partially offset by start-up costs associated with a new facility in the northeast and a loss from operations of MLI.
Financial Services
The following table summarizes significant items affecting comparability within the Financial Services segment:
Quarter Ended March 31 | ||||||||
2003 | 2002 | |||||||
Earnings before Income Taxes | ||||||||
Thousands of dollars | ||||||||
As reported | $ | (6,522 | ) | $ | (12,074 | ) | ||
Included in earnings from operations: | ||||||||
Restructuring and impairment charges | $ | (573 | ) | $ | (21 | ) | ||
By-product revenues |
| 232 |
|
| 335 |
| ||
Insurance recovery related to 9/11 |
| 2,047 |
|
| — |
| ||
Total items affecting comparability | $ | 1,706 |
| $ | 314 |
| ||
Net sales for the Financial Services segment decreased $13 million, or 12.3%, from a year ago. Financial Services’ net sales are comprised primarily of capital markets and customized communications solutions. First quarter 2003 capital markets net sales decreased 18.1% between years, as domestic capital markets net sales were down 22.1%, partially offset by an increase of 4.9% in international capital markets net sales. Declines in net sales from domestic capital markets transactions (e.g., S-filings, including initial public offerings, secondary offerings and mergers and acquisitions) caused by the slowed economy more than offset increased net sales from compliance filings (e.g., SEC periodic reports and annual meeting proxy statements). First quarter 2003 net sales from customized communications solutions decreased 13.0% between years, due to declines from investor communications (e.g., prospectuses, Form N, annual and quarterly mutual funds statements), which reflected contraction in the mutual fund market and one large non-recurring deal from 2002.
First quarter value-added revenue for the Financial Services segment decreased $12 million, or 13.4%, between years consistent with the decline in net sales. The percentage decrease in value-added revenue was higher than the decrease in net sales due to a mix shift toward more compliance work.
First quarter 2003 loss from operations was $6 million, an improvement from $12 million for the year ago period. Included in the 2003 first quarter loss from operations was a $2 million gain on an insurance recovery related to September 11th that reduced cost of sales. Improved operating margins in the first quarter of 2003 also reflect savings from productivity initiatives, as well as prior restructuring actions which included the closing of several print facilities and service centers, and related workforce reductions. First quarter 2003 operating margins were negatively impacted by the lower goodwill amortization,level of capital markets activity between years, because of the disproportionately higher margins that capital markets work generates.
Other and Corporate
The following table summarizes significant items affecting comparability within the Other and Corporate segments:
Quarter Ended March 31 | ||||||||
2003 | 2002 | |||||||
Earnings before Income Taxes | ||||||||
Thousands of dollars | ||||||||
As reported | $ | (33,429 | ) | $ | (29,669 | ) | ||
Included in earnings from operations: | ||||||||
Restructuring and impairment charges | $ | (1,867 | ) | $ | (3,525 | ) | ||
By-product revenues |
| 1,227 |
|
| 893 |
| ||
Gain on sale of assets |
| 357 |
|
| — |
| ||
Provision for doubtful accounts |
| (9,966 | ) |
| (3,223 | ) | ||
Pension and postretirement benefit income(1) |
| 15,855 |
|
| 21,021 |
| ||
| 5,606 |
|
| 15,166 |
| |||
Included in other income (expense): | ||||||||
Affordable housing amortization |
| (4,000 | ) |
| (2,700 | ) | ||
COLI-related expenses upon policy surrender |
| — |
|
| (4,883 | ) | ||
| (4,000 | ) |
| (7,583 | ) | |||
Total items affecting comparability | $ | 1,606 |
| $ | 7,583 |
| ||
(1) | Excludes service costs, which is recorded primarily in Donnelley Print Solutions, Logistics Services and Financial Services. |
Net sales for RRD Direct were down 14.2% between years, primarily due to lower volumes, partially offset by higher prices. First quarter net sales for International were up 10.2% between years, driven by volume growth in Europe and Asia, partially offset by declines in Latin America.
First quarter value-added revenue from print logisticsfor RRD Direct decreased $1 million or 5.5%, compared with a 14.2% decline in net sales, driven by higher customer-furnished paper in 2003. Value-added revenue for International was up $7 million between years, due to increases in Asia and higher processing costs, including increased overtime, related to higher package volume.
The loss from operations for the “Other”Other business segment was $12$9 million for the thirdfirst quarter of 2002,2003, compared with a loss of $27$15 million for the year ago period. Of$2 million of the $15$6 million improvement in operating results between years, $9 millionis related to lower restructuring charges and $3 million to lower spending for complementary businesses. The third quarter loss from operations for Financial Services worsened between years driven primarily by the continued slowdown in capital markets.impairment charges. RRD Direct’s loss from operations improved between years, driven by restructuring savings and increased productivity.productivity improvements. Earnings from operations for International in the thirdfirst quarter of 20022003 benefited from
The loss from operations for the Corporate segment was $12$7 million in the thirdfirst quarter of 20022003 compared with earnings of $12$10 million in the thirdfirst quarter of 2001.2002. The third quarter of 2002 included $13$17 million in restructuring and impairment charges, $8 million of which related to the curtailment charge for the company’s postretirement benefit plans. The decrease in operating earnings between years was also driven by an additional provision for doubtful accounts ($5 million), lower benefit plan earnings ($35 million), higher affordable housing amortization ($1 million), higher management incentive compensation and gainsharing ($4 million) and higher unallocated corporate administrative and other expenses.
Thousands of dollars | 2002 | % of Sales | 2001 | % of Sales | % Change | ||||||||||
Cost of materials | $ | 344,596 | 29.3 | % | $ | 400,985 | 31.1 | % | (14.1 | %) | |||||
Cost of transportation | 148,343 | 12.6 | % | 147,752 | 11.5 | % | 0.4 | % | |||||||
Cost of manufacturing* | 372,891 | 31.7 | % | 423,631 | 32.9 | % | (12.0 | %) | |||||||
Depreciation | 71,692 | 6.1 | % | 77,042 | 6.0 | % | (6.9 | %) | |||||||
Amortization | 8,651 | 0.7 | % | 14,013 | 1.1 | % | (38.3 | %) | |||||||
Selling and administrative expenses* | 131,740 | 11.2 | % | 132,429 | 10.3 | % | (0.5 | %) | |||||||
Restructuring and impairment charges | 22,709 | 1.9 | % | 19,860 | 1.5 | % | 14.3 | % | |||||||
Net interest expense | 16,937 | 1.4 | % | 18,831 | 1.5 | % | (10.1 | %) |
Nine Months Ended September 30 | ||||||||||||||||||||||||
Thousands of dollars, except per share data | 2002 | 2001 | ||||||||||||||||||||||
Earnings before Income Taxes | Net Income | Per Diluted Share | Earnings before Income Taxes | Net Income | Per Diluted Share | |||||||||||||||||||
Restructuring and impairment charges | $ | (65,426 | ) | $ | (40,111 | ) | $ | (0.35 | ) | $ | (91,895 | ) | $ | (56,515 | ) | $ | (0.47 | ) | ||||||
Reversal of excess COLI tax reserves | — | 30,000 | 0.26 | — | — | — | ||||||||||||||||||
Other investment write-downs | — | — | — | (2,040 | ) | (1,255 | ) | (0.01 | ) | |||||||||||||||
Impact of prior year goodwill amortization | — | — | — | (13,352 | ) | (10,193 | ) | (0.09 | ) | |||||||||||||||
Total | $ | (65,426 | ) | $ | (10,111 | ) | $ | (0.09 | ) | $ | (107,287 | ) | $ | (67,963 | ) | $ | (0.57 | ) | ||||||
Net Sales | Value-Added Revenue | |||||||||||||||||
Thousands of dollars | 2002 | 2001 | % Change | 2002 | 2001 | % Change | ||||||||||||
Magazines, Catalogs and Retail | $ | 1,127,493 | $ | 1,363,801 | (17.3 | %) | $ | 709,271 | $ | 846,676 | (16.2 | %) | ||||||
Book Publishing Services | 526,349 | 542,220 | (2.9 | %) | 377,524 | 379,997 | (0.7 | %) | ||||||||||
Telecommunications | 459,374 | 527,731 | (13.0 | %) | 224,238 | 234,781 | (4.5 | %) | ||||||||||
Premedia Technologies | 88,813 | 106,807 | (16.8 | %) | 88,819 | 106,807 | (16.8 | %) | ||||||||||
Donnelley Print Solutions | 2,202,029 | 2,540,559 | (13.3 | %) | 1,399,852 | 1,568,261 | (10.7 | %) | ||||||||||
Logistics Services | 541,565 | 562,395 | (3.7 | %) | 131,158 | 118,078 | 11.1 | % | ||||||||||
Financial Services | 340,949 | 391,635 | (12.9 | %) | 288,440 | 327,415 | (11.9 | )% | ||||||||||
RRD Direct | 104,752 | 132,394 | (20.9 | %) | 61,321 | 72,074 | (14.9 | )% | ||||||||||
International (1) | 230,527 | 252,599 | (8.7 | %) | 116,730 | 123,163 | (5.2 | %) | ||||||||||
Other | — | 3,355 | N/M | — | 6,718 | N/M | ||||||||||||
Total Other | 676,228 | 779,983 | (13.3 | %) | 466,491 | 529,370 | (11.9 | %) | ||||||||||
Total | $ | 3,419,822 | $ | 3,882,937 | (11.9 | %) | $ | 1,997,501 | $ | 2,215,709 | (9.8 | %) | ||||||
A summary analysis of expense trendsexpenses is presented below:
Nine MonthsFirst Quarter Ended September 30March 31
Thousands of dollars | 2002 | % of Sales | 2001 | % of Sales | % Change | ||||||||||
Cost of materials | $ | 1,010,031 | 29.5 | % | $ | 1,222,912 | 31.5 | % | (17.4 | %) | |||||
Cost of transportation | 412,290 | 12.1 | % | 444,316 | 11.4 | % | (7.2 | %) | |||||||
Cost of manufacturing* | 1,183,159 | 34.6 | % | 1,313,423 | 33.8 | % | (9.9 | %) | |||||||
Depreciation | 217,503 | 6.4 | % | 239,319 | 6.2 | % | (9.1 | %) | |||||||
Amortization | 29,139 | 0.9 | % | 43,097 | 1.1 | % | (32.4 | %) | |||||||
Selling and administrative expenses* | 393,641 | 11.5 | % | 408,366 | 10.5 | % | (3.6 | %) | |||||||
Restructuring and impairment charges | 65,426 | 1.9 | % | 91,895 | 2.4 | % | (28.8 | %) | |||||||
Net interest expense | 49,683 | 1.5 | % | 55,132 | 1.4 | % | (9.9 | %) |
Thousands of dollars | 2003 | % of Sales | 2002 | % of Sales | % Change | ||||||||||
Cost of materials | $ | 296,984 | 27.7 | % | $ | 333,905 | 30.5 | % | (11.1 | %) | |||||
Cost of transportation |
| 158,763 | 14.8 | % |
| 128,200 | 11.7 | % | 23.8 | % | |||||
Cost of manufacturing* |
| 383,552 | 35.7 | % |
| 393,984 | 36.0 | % | (2.6 | %) | |||||
Depreciation |
| 68,236 | 6.4 | % |
| 72,120 | 6.6 | % | (5.4 | %) | |||||
Amortization |
| 9,038 | 0.8 | % |
| 9,747 | 0.9 | % | (7.3 | %) | |||||
Selling and administrative expenses* |
| 136,749 | 12.7 | % |
| 127,877 | 11.7 | % | 6.9 | % | |||||
Restructuring and impairment charges |
| 2,609 | 0.2 | % |
| 26,692 | 2.4 | % | (90.2 | %) | |||||
Net interest expense |
| 12,707 | 1.2 | % |
| 15,453 | 1.4 | % | (17.8 | %) |
*Excludes |
Restructuring and Impairment: The following discussion should be read in conjunction with Note 4, “Restructuring and Impairment,” in the 2002 Annual Report on Form 10-K, and Note 10 to the condensed consolidated financial statements.
During the first quarter of 2003, we recorded pretax restructuring and impairment charges of $2.6 million ($1.6 million after-tax, or $0.01 per diluted share). The total pretax restructuring and impairment charges by business segment were: Donnelley Print Solutions: $0.2 million; Financial Services: $0.6 million; Other: $0.7 million; and Corporate: $1.1 million. Restructuring charges include employee termination benefits, including severance, early retirement benefit costs and outplacement costs associated with planned personnel reductions and employee and asset relocation costs.
During the first quarter of 2002, we recorded pretax restructuring and impairment charges of $27 million ($17 million after-tax, or $0.14 per diluted share). The total pretax restructuring and impairment charges related to restructuring actions announced during 2002 by business segment were: Donnelley Print Solutions: $23 million; Other: $3 million; and Corporate: $1 million.
We regularly assess our manufacturing platforms to assure that they are efficient, flexible and aligned properly with our customers’ needs. In March 2001, we announced a $300 million upgrade in our print platform, approximately one-third of which related to restructuring costs. We intend to create a more efficient, flexible and integrated print platform to better serve our magazine, catalog and retail customers within the Donnelley Print Solutions segment. This upgrade program includes the purchase of seven new presses and associatedtwo binding lines, four of which have beenfour presses and two binding lines were placed ininto service as of March 31, 2003. As of March 31, 2003, cumulative capital expenditures related to date. As wethis upgrade facilities, certain existing equipment with minimal book value is being either retired or sold. Capital expenditures for this program through September 30, 2002 were $157$199 million, $61$20 million of which was spent inoccurred during the first nine monthsquarter of 2002.2003. We planexpect to spend an additional $23 million in 2003 to complete the upgrade program by mid-2003. We expect total capital spending for the full year 2002, including the upgrade program, to be less than $280 million.
As part of our effortefforts to build a more effective print platform, we continually assess each plant’s scale of operations and geographic location relative to our entire print platform. During the first quarter of 2002, we announced the closure of theour Berea, Ohio manufacturing facility. We completed the closures of the Berea, Ohio as well asplant, and the Des Moines, Iowa and the Old Saybrook, Connecticut plants, which were announced in 2001, during the second quarter of 2002.
As we complete our upgrade program and fully transition allcontinuing customer work from closed facilities, we expect to improve the overall performance of our print platform. This shouldwill include improvements in cycle times and lessreduced waste through the addition of faster, more efficient equipment to our networked platform and greater economies of scale.
The two largest plant closures announced in 2001 (Old Saybrook, Connecticut and Des Moines, Iowa) did not cease operations until the second quarter of 2002. Accordingly, the first quarter of 2003 reflects the benefits as a result of allthese plant closures as compared to the first quarter of 2002. Additionally, other restructuring actions netannounced subsequent to the first quarter of the incremental costs associated with the print platform upgrade, we expect to realize cost2002 also impact 2003 savings in 2002 of approximately $124 million, of which approximately $120 million is the cash component and approximately $4 million is non-cash, related to lower depreciation expense.from restructuring activities. During the first nine monthsquarter of 2002,2003 we realized approximately $82 million in cost savings from the restructuring actions taken. Of this amount,of approximately $79$20 million, was the cash component,consisting primarily of lower salary expense and approximately $3 million was non-cash, related to lower depreciation expense.employee benefit costs. These savings, however,reductions in our cost structure in 2003 were largely offset by the impact of volume reductions and pricing pressures that continuedreductions during the quarter. We expect to affect the company during 2002.
Cash Flows fromFrom Operating Activities
Cash flow fromprovided by operating activities was $245totaled $68 million forin the nine months ended September 30, 2002, a decreasefirst quarter of $762003, compared with cash provided by operating activities of $73 million fromin the same period of 2001.2002. The decrease between years was primarily due to the payment of approximately $130 million related to the COLI settlement (see Note 7 to the condensed consolidated financial statements) and lower net income excluding non-cash charges and an increase in 2002,other assets partially offset by a 2001 payment of $62 million related to COLI (see Note 7lower investment in working capital, driven by lower contributions to the condensed consolidated financial statements).
Our cash conversion cycle (days’ sales outstanding plus days’ inventory on hand minus days’ payable outstanding) improved to 4338 days as compared with 4947 days a year ago. The ratio of operating working capital* to sales excluding restructuring and impairment reserves, also improved to 3.4%1.6% in 20022003 from 6.0%4.7% in 2001.
* The operating working capital to sales ratio is defined as a 13-month average of net receivables, net inventories and prepaid expenses minus accounts payable, accrued compensation and other accrued liabilities, divided by 12-month rolling net sales.
Cash Flows fromFrom Investing Activities
Our principal recurring investing activities are capital expenditures to improve the productivity ofour operations. In the first nine monthsquarter of 2002,2003, capital expenditures and investments totaled $182$67 million, a $19$1 million increase from a year ago. 2003 included the acquisition of a package logistics business within Donnelley Logistics for approximately $17 million in cash. We expect full year capital spending, excluding acquisitions, to be below $280$250 million compared with capital spending of $273$242 million in 2001. This planned level2002.
Acquisitions
On March 6, 2003, the company acquired certain net assets of spending in 2002 is driven by investments to createMomentum Logistics, Inc. (MLI), a more efficient print platform to serve our magazine, catalog and retail customers. Through 2003, we expect to invest up to $300Florida-based provider of package distribution services, for approximately $17 million in this print platform, approximatelycash. MLI operates sortation facilities and a thirddedicated fleet of which relatesvehicles to restructuring activities, to create fewer, largerprovide business-to-business and more efficient facilities focusedbusiness-to-consumer package distribution services. The purchase price has been allocated based on specific capabilities.
We made no business acquisitions in 2002 or 2001.
Cash Flows fromFrom Financing Activities
Financing activities include net borrowings, dividend payments and share repurchases. As of September 30, 2002,At March 31, 2003, our net short-term and long-term borrowings increased $28by $4 million from December 31, 2001,2002, compared with an increase of $97$34 million for the same period of 2001. This2002. The lower level of incrementalincrease in net borrowings in 2002 ($6930 million) is primarily due to the expiration of the company’s share repurchase program on January 31, 2002, partially offset by the company’s payment of approximately $130 million related to the COLI settlement (see Note 7 to the condensed consolidated financial statements).2002. During the first nine monthsquarter of 2002, cash used for share repurchases, net of proceeds from stock option exercises, was $6 million compared with $197 million in 2001.
Liquidity
Commercial paper is our primary source of short-term financing. On September 30, 2002,March 31, 2003, we had $107$134 million outstanding in domestic commercial paper borrowings. In addition, at September 30, 2002,March 31, 2003, we had $431$350 million of unused revolving credit facilities with a number of banks. These facilities providedprovide support for issuing commercial paper and other credit needs. In October 2002, we replaced our existing revolving credit facilities with two new revolving credit facilities. The new facilities consist of a short-term facility that matures in October 2003 and provides for borrowings of up to $175 million and a long-termlong- term facility that matures in October 2007 and also provides for borrowings of up to $175 million. The company pays an annual commitment fee on the total unused portion of the credit facilities of 0.07% for the short-term facility and 0.09% for the long-term facility. The facilities bear interest at variable rates based on the current LIBOR rate and the company’s credit rating. As of November 12, 2002,May 13, 2003, there have been no borrowings under these credit facilities. Management believes that cash flow and borrowing
capability are sufficient to fund operations and planned capital expenditures of the company for the forseeable future.
Environmental Health and Safety—Our business is subject to various laws and regulations governing employee health and safety and environmental protection. Our policy is to comply with all
We do not anticipate that compliance with laws and regulations in these areas will have a material adverse effect on our competitive or consolidated financial position.
Litigation—For a discussion of certain litigation involving the company, see Note 4 to the condensed consolidated financial statements.
Outlook—The environment is 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.markets exacerbated by recent drops in market demand. Therefore,competition is intense. Our intent is to differentiate our service offerings so thatwethat we are viewed by our customers as a partner thatwho can help them deliver effective and targeted communications in the right format to the right audience at the right time.
We are a large user of paper, supplied to us by our customers or purchasedbought 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 anticipatesee any disruptive conditions affecting prices andor supply of paper in 2002.
Postal costs are a significant component of our customers’ cost structures and postal rate changes can influence the number of pieces that our customers are willing to mail. Any resulting decline in print volumes mailed could have an effect on our financial results. Postal rates increased in January and2001, July 2001 and an additional increase was effective beginning in July 2002. Postal rate increases are not expected to occur again until 2006. Postal rate increases can 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 the operating costs of our print-related businessesin the Donnelley Print Solutions and Financial Services segments and transportation costs in Donnelley Logistics.the Logistics Services segment. In Donnelley Logistics Services, increases in fuel costs can be offset by fuel surcharges passed on to customers, but continuing increasescustomers. Increases in other energy costs beyond those planned could affect theour consolidated financial results.
Consumer confidence and economic growth are key drivers of demand for our services. The slowdown experienced in the U.S. and international economies is continuing to affectaffecting demand across most of our businesses. Uncertainty in the economy has led certain ofcustomers across our customersend-markets to indicate that they anticipate flat or falling demand in their end markets for the remainder of 2002.
In the longer term, technological changes, including the electronic distribution of information, present both risks and opportunities for the company.us. Many of the company’sour businesses leverage our distinctive capabilities to participate in the rapid growth in electronic communications. Our goal remains to help our customers succeed by delivering effective and targeted communications in 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.
Quantitative and Qualitative Disclosures About Market Risk
The company is exposed to market risk from changes in interest rates and foreign currency exchange rates. As such, the company monitors the interest rate environment and modifies the components of its debt portfolio as necessary to manage funding costcosts and interest rate risks. Generally, the company maintains at least half of its debt at fixed rates (approximately 50.4%54.3% at September 30, 2002)March 31, 2003). Included in floatingExcluded from the calculation of fixed rate debt at March 31, 2003 is $200 million in fixed rate debt that was swapped to floating rates in order to take advantage of lower interest rates on floating rate debt. The swap was executed in two transactions that mature in November 2006. To reduce its exposure to future increases in floating interest rates, the company entered into additional floating to fixed swap agreements, effectively fixing the interest rates for the May 15, 2002, November 15, 2002, May 15, 2003 and November 15, 20022003 interest rate resets on the original swaps (see Note 9 to the condensed consolidated financial statements).swaps. The company’s exposure to adverse changes in foreign exchange rates is immaterial to the consolidated financial statements of the company as a whole.company. The company occasionally uses other financial instruments to hedge exposures to interest rate and foreign exchange rate changes. The company does not useuses derivative financial instruments as a risk management tool, and not for trading purposes and is not a party to any leveraged derivatives.or speculative purposes. For further discussion relating to financial instruments, see the “Debt Financing and Interest Expense” footnoteNote 9 to the condensed consolidated financial statements included in the company’s 2001 Annual Report on Form 10-K.
Controls and Procedures
The Chairman, President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer of the company have concluded, based on their evaluation as of a date within 90 days prior to the date of the filing of this quarterly report on Form 10-Q, that the company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and include controls and procedures designed to ensure that information required to be disclosed by the company in such reports is accumulated and communicated to the company’s management, including the Chairman, President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
There have not been any significant changes in the company’s internal controls or in other factors that could significantly affect such controls subsequent to the date of such evaluation.
PART II
OTHER INFORMATION
The company previously reported the settlement of November 25, 1996, and June 30, 1998, 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, athree class action was broughtcases filed against it, as well as settlement of a portion of a fourth class action. The settlement and the company alleging age discrimination in connection with the 1993 closingportion of the company’s Chicago catalog operations, and violation of the Employee Retirement Income Security 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 actionscase remaining are described in Note 4 to the condensed consolidated financial statements contained in Part I, Item 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 27, 2003. |
(b) | The following matters were voted upon at the Annual Meeting of Stockholders. |
1. | The election of the nominees for Directors of Class 3, who will serve for a term to expire at the Annual Meeting of Stockholders to be held in 2006, was voted on by the Stockholders. The nominees, all of whom were elected, were Gregory Q. Brown, James R. Donnelley, Thomas S. Johnson and Norman H. Wesley. The Inspectors of Election certified the following vote tabulations: |
For | Withhold Authority | |||
Gregory Q. Brown | 95,135,180 | 4,108,993 | ||
James R. Donnelley | 95,686,650 | 3,557,523 | ||
Thomas S. Johnson | 93,410,150 | 5,834,023 | ||
Norman H. Wesley | 93,452,944 | 5,791,229 |
2. | A stockholder proposal regarding a sustainability report was rejected by the Stockholders. The Inspectors of Election certified the following vote tabulations: |
For | % | Against | % | Abstain | % | Non-Vote | % | |||||||
4,313,980 | 4% | 81,035,276 | 82% | 2,658,431 | 3% | 11,236,506 | 11% |
3. | A stockholder proposal regarding expensing the costs of options was rejected by the Stockholders. The Inspectors of Election certified the following vote tabulations: |
For | % | Against | % | Abstain | % | Non-Vote | % | |||||||
35,335,690 | 36% | 50,553,447 | 51% | 2,118,500 | 2% | 11,236,506 | 11% |
Certain statements in this filing, including the discussions of management expectations for 2002,2003, constitute “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 20012002 Annual Report on Form 10-K for a description of such factors.
(a)Exhibits
10.1 |
Amended and Restated R.R. Donnelley & Sons Company | ||
10.2 | Amendment No. 1 to the Amended and Restated R.R. Donnelley & Sons Company | |
10.3 | Amendment No. 2 to the Amended and Restated R.R. Donnelley & Sons Company Unfunded Supplemental Benefit Plan | |
12 | Ratio of Earnings to Fixed Charges | |
99.1 | Certification pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code | |
99.2 | Certification pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code |
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)
Date: | May 14, 2003 | |
Certification Pursuant to Rule 13a-14 and Rule 15d-14
of the Securities Exchange Act of 1934
I, William L. Davis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of R.R. Donnelley & Sons Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/S/ WILLIAM L. DAVIS
William L. Davis
Chairman, President and Chief Executive Officer
Certification Pursuant to Rule 13a-14 and Rule 15d-14
of the Securities Exchange Act of 1934
I, Gregory A. Stoklosa, certify that:
1. I have reviewed this quarterly report on Form 10-Q of R.R. Donnelley & Sons Company;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/S/ GREGORY A. STOKLOSA
Gregory A. Stoklosa
Executive Vice President and Chief Financial Officer
36