FORM 10-Q


 
 
 
  

 
 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, 1999
   March 31, 2000

 
 

 
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

   		
  

   

     36-1004130
 
(I.R.S.
     Employer

   
Identification
     No.)

   
 
77 West Wacker
   Drive,
 

 Chicago, Illinois
(Address of
   principal executive offices)


 

   
60601

  

 


 

  

   
77 West Wacker
     Drive,
   

   Chicago, Illinois
(Address of principal executive offices)

   

     60601
 
(Zip
     Code)

   		
  

 

 
 

 
Registrant’s
   Telephone Number (312) 326-8000

 
 

 
         Indicate by check
   mark whether the registrant (1) has filed all reports required to be filed
   by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
   preceding 12 months (or for such shorter period that the registrant was
   required to file such reports), and (2) has been subject to the filing
   requirements for the past 90 days.

 
 


 

  

   
    
ü

   		
  

 


 

  

   
    
Yes

   		
  

 


 

  

   
    

   		
  

 


 

  

   
    
No

   		
  

 


 

  

   
    

   		
  

 

 
 


 

  

   
    
Number of shares
     of common stock outstanding

   		
  

 


 

  

   
    
     as of October 31, 1999April 30, 2000

   		
  

 


 

  

   
    

     126,441,429121,906,718

   		
  

 

 
 

 
 
 

   PART I

 
 

 
FINANCIAL INFORMATION

 
 

 
Item
   1. Financial Statements

 
 


 

  

   Index

       
   Page
   

   Number(s)

  

  

             
                
        Condensed Consolidated Statements of Income (Unaudited)
     for the
   


                
                
            three and nine months ended September 30,March 31,
     2000 and 1999 and 1998		
       
   3
  

  
 
  

             
                
        Condensed Consolidated Balance Sheets (Unaudited) as of March 31,
     2000
   


                
                
            September 30, 1999(Unaudited) and December 31,
     19981999		
       
   4
  

  
 
  

             
                
        Condensed Consolidated Statements of Cash Flows
     (Unaudited) for
   


                
                
            the ninethree months ended September 30,March 31,
     2000 and 1999 and 1998		
       
   5
  

  
 
  

             
                
        Notes to Condensed Consolidated Financial Statements
   


                
                
            (Unaudited)		
       
   6 - 9
  

  
 
  

   Item
     2. Management’s Discussion and Analysis of Financial Condition
     and Results of Operations
    
   

              
                 
         Comparison of ThirdFirst Quarter and2000 to First Nine MonthsQuarter
      1999 to 1998
        
    10 - 14
      
 
   
                 
                
    Changes in Financial Condition  14
   

   
 
   

              
                 
         
    Subsequent EventsChanges in Financial Condition
        
    14 - 15
   

   
 
   

              
                 
         Year 2000 and System Infrastructure
        
    15 - 16
      
   

   
 
   

              
                 
         Other Information
        
    1615 - 17
      18
   

   
 
   

    Item
      3. Quantitative and Qualitative Disclosures about Market
      Risk
        
    1718
   

   
 
   

    PART II
     
    

     OTHER INFORMATION
      
     

      Item
        1. Legal Proceedings
          
      1819
     

     
 
     

      Item
        5. Other Information4. Submission of Matters to a Vote of Security
        Holders
          
      1819
     

     
 
     

      Item
        5. Other Information    19
 
Item
        6. Exhibits and Reports on Form 8-K
          
      1820
     

    

    
 R.R. DONNELLEY
      & SONS COMPANY AND SUBSIDIARIES

    
 

    

    
 

    
CONDENSED
      CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

    
 

    
(Thousands of
      dollars, except share data)Dollars, Except Per-Share Data)

    
 


    

     

       
          
      Three Months
        Ended
      

      September 30March 31
  
        Nine Months Ended
      

      September 30

     

     

       
          2000
    
      1999
  1998
        
  1999
        
  1998
        

     

     

      Net
        sales
          
      $  
          1,340,1431,342,970
       
          
      $
         
          1,274,479   $  
          3,715,129   $  
          3,604,0401,231,404
       
     

     

      Cost of
        sales
          
      1,018,4881,101,947
       
          
      980,459988,468   2,891,289   2,851,213
       
     

     

        
        
      

        
        
      
    
    

        
     

     

      Gross
        profit
          
      321,655241,023
       
          
      294,020242,936   823,840   752,827
       
     

     

      Selling and
        administrative expenses
          
      163,965145,882
       
          
      145,776151,361 
    
    
  
Earnings from
        operations    95,141
       
          
      471,67191,575 
Other income
        (expense):
Interest
        expense    (22,141)    (19,896)
Other,
        net    2,937
       
          
      419,4252,792 
    
    
  
Earnings from
        continuing operations before income taxes    75,937     74,471
       
     

     

      Income
        (loss)
        from operations of businesses
      

           held for saletaxes		
          
      — 
        29,236
       
          
      — 
        28,671 
    
    
  
Income from
        continuing operations     46,701
       
          
      (4,89045,800
      ) 
Loss from
        discontinued operations, net of income taxes
          —      
      (80,0671,820
      )
     

     

        
        
      

        
        
      
    
    

        
     

     

      Earnings from
        operationsNet
        income
          
      157,690   148,244   347,279   253,335 
Other income
        (expense):        
Interest expense
          (23,084)  (19,400)  (66,705)  (59,036)
Gain on sale of
        Metromail shares  — 
        $      46,701
       
          
      — 
        $       
         43,980   — 
           145,656 
Gain on sale of
        DESI  — 
           23,247   — 
           23,247 
Other income
        —net shares  4,559   2,079   15,447   3,960
       
     

     

        
        
      

        
        
      
    
    

        
     

     

      Earnings before
        income taxes  139,165   154,170   296,021   367,162 
Provision for
        income taxes  53,578   54,927   113,968   164,975 
    
    
    
    
  
Net income
          85,587   99,243   182,053   202,187 
    
    
    
    
  
 
Net incomeIncome from
        continuing operations per share of common stock:stock
          
      
      
             
      
      
     

     

           Basic
          $         
         0.38     
      $         
           
          0.670.34 
     Diluted    0.38
       
          0.34 
Loss from
        discontinued operations per share of common stock          
     Basic    $         
         —      $         
         (0.01)
     Diluted    —      (0.01)
Net income per
        share of common stock        
Basic    $         
         0.38     
      $         
           
          0.72   $  
                  
          1.40   $  
                  
          1.430.33
       
     

     

      Diluted
          
      $  
                  
          0.670.38
       
          
      $  
                  
          0.71   $  
                  
          1.39   $  
                  
          1.41 
 
Cash dividends
        per basic share  $  
                  
          0.22   $  
                  
          0.21   $  
                  
          0.64   $  
                  
          0.61 
 
 
Average basic
        shares outstanding   
        127,608,000    
        138,075,000    
        130,089,000    
        140,982,000 
Average diluted
        shares outstanding   
        128,408,000    
        140,245,000    
        131,234,000    
        143,211,0000.33
       
     

    

    

    
 

    
See accompanying
      Notes to Condensed Consolidated Financial Statements.

    
 R.R. DONNELLEY
      & SONS COMPANY AND SUBSIDIARIES

    
 

    

    
 

    
CONDENSED
      CONSOLIDATED BALANCE SHEETS (UNAUDITED)

    
 

    
September 30, 1999March 31, 2000
      and December 31, 19981999

    
(Thousands of
      dollars, except share data)

    
 


    

     

      ASSETS
     

     

       
          2000
    
      1999
  1998
        

     

     

      Cash and
        equivalents
          
      $       66,67348,270
       
          
      $       66,22641,873
       
     

     

      Receivables,
        less allowance for doubtful accounts of $17,255 in 1999 and$16,844
      

           $14,279 in 19982000 and $15,461 in 1999		
          
      924,308842,854
       
          
      843,094865,305
       
     

     

      Inventories
          
      224,566211,229
       
          
      182,931194,312
       
     

     

      Prepaid
        expenses
          
      49,422113,784
       
          
      63,04051,781 
Refundable
        income taxes    76,579     76,579
       
     

     

        
        
      

        
        
      

        
     

     

               
         Total current assets
          
      1,264,9691,292,716
       
          
      1,155,2911,229,850
       
     

     

        
        
      

        
        
      

        
     

     

      Property,Net property,
        plant and equipment, at cost, less accumulated depreciation of
      

           $2,883,536 in 2000 and $2,822,737 in
        1999		
          
      4,623,8491,706,141
       
          
      4,368,7541,710,669 
Accumulated
        depreciation  2,879,025   2,667,827 
    
    
  
  
                Net property,
        plant and equipment  1,744,824   1,700,927
       
     

     

      Goodwill and
        other intangibles, net of accumulated amortization
      of $205,330
      

           of $229,293 in 2000 and $217,616 in
        1999 and $183,589 in 1998		
          
      384,429555,637
       
          
      381,394397,983
       
     

     

      Other noncurrent
        assets
          
      544,610558,165
       
          
      515,029514,962 
Net assets of
        businesses held for sale  40,582   45,476
       
     

     

        
        
      

        
        
      

        
     

     

               
         Total assets
          
      $3,979,414
        4,112,659
       
          
      $3,798,117
        3,853,464
       
     

     

        
        
      

        
        
      

        
     

     
 
     

      LIABILITIES
        AND SHAREHOLDERS’ EQUITY
      
Accounts payable
          $  
          334,592
       
        
       
Accounts
        payable    $     331,257326,239     $    334,389
       
     

     

      Accrued
        compensation
          
      170,230144,962
       
          
      188,187175,590
       
     

     

      Short-term
        debt
          
      60,000674,835
       
          
      60,000419,555
       
     

     

      Current and
        deferred income taxes
          
      42,78020,412
       
          
      2,26310,894
       
     

     

      Other accrued
        liabilities
          
      319,377308,454
       
          
      242,251263,035
       
     

     

        
        
      

        
        
      

        
     

     

               
         Total current liabilities
          
      926,9791,474,902
       
          
      823,9581,203,463
       
     

     

        
        
      

        
        
      

        
     

     

      Long-term
        debt
          
      1,300,122752,231
       
          
      998,978748,498
       
     

     

      Deferred income
        taxes
          
      256,886250,284
       
          
      260,692252,884
       
     

     

      Other noncurrent
        liabilities
          
      386,644519,595
       
          
      413,611510,361
       
     

     

          
    
  
         
         Total noncurrent liabilities    1,522,110     1,511,743 
    
    
  
Shareholders’ equity:
          
      
      
          
      
      
     

     

               
         Common stock at stated value ($1.25 par value)
          
      
      
          
      
      
     

     

               
                    Authorized shares: 500,000,000;
        Issued 140,889,050 in 19992000 and 

                 
                  
            140,889,050 in 19981999		
          
      308,462
       
          
      308,462
       
     

     

               
         Retained earnings
          
      1,390,4631,510,896
       
          
      1,325,6341,521,474
       
     

     

               
         Cumulative
        translation adjustmentsAccumulated other comprehensive income
          
      (67,41459,181
      )
          
      (55,05064,154
      )
     

     

               
         Unearned compensation
          
      (6,9478,991
      )
          
      (6,1186,222
      )
     

     

               
         Reacquired common stock, at cost
          
      (515,781635,539
      )
          
      (272,050621,302
      )
     

     

        
        
      

        
        
      

        
     

     

               
                   
                   Total
        shareholders’ equity
          
      1,108,7831,115,647
       
          
      1,300,8781,138,258
       
     

     

        
        
      

        
        
      

        
     

     

               
                   
                   Total
        liabilities and shareholders’ equity
          
      $3,979,414
        4,112,659
       
          
      $3,798,117
        3,853,464
       
     

     

        
        
      

        
        
      
  
 
See accompanying Notes to Condensed Consolidated
      Financial Statements.
 
R.R. DONNELLEY & SONS COMPANY AND
      SUBSIDIARIES
 
 

    CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
For the Nine Months Ended September 30
(Thousands of dollars)
 
   1999
        
  1998
        
Cash flows
        provided by (used for) operating activities:    
  
                Net income
          $  
        182,053   $  
        202,187 
  
                Loss from
        operations of businesses held for sale, net of tax  3,010   80,067 
  
                Gain on sale of
        Metromail, net of tax  — 
           (87,394)
  
                Gain on sale of
        DESI, net of tax  — 
           (13,948)
  
                Depreciation
          242,358   242,272 
  
                Amortization
          36,158  38,162 
  
                Gain on sale of
        assets  (4,794)  (7,855)
  
                Net change in
        operating working capital  (72,205)  (17,540)
  
                Net change in
        other assets and liabilities  (224)  36,312 
  
                Other  12,646   (10,745)
    
    
  
Net cash
        provided by operating activities  399,002   461,518 
    
    
  
Cash flows
        provided by investing activities:    
  
                Capital
        expenditures   (198,267
        )  (159,083)
  
                Other
        investments including acquisitions, net of cash acquired  (170,394)  (49,994)
  
                Dispositions of
        assets  5,630   15,657 
  
                Disposition of
        Metromail, net of tax  — 
           238,438 
  
                Disposition of
        DESI, net of tax  — 
           35,641 
    
    
  
Net cash
        provided by (used for) investing activities  (363,031)   80,659
        
    
    
  
Cash flows
        provided by (used for) financing activities:    
  
                Net increase
        (decrease) in borrowings  299,216   (66,987)
  
                Issuances of
        common stock  15,196   64,324 
  
                Acquisition of
        common stock  (265,154)   (443,674
        )
  
                Cash dividends
        on common stock  (83,429)  (86,477)
    
    
  
Net cash used
        for financing activities  (34,171)  (532,814)
    
    
  
Effect of
        exchange rate changes on cash and equivalents  (1,353)  (174)
Net increase in
        cash from businesses held for sale  — 
           29,169 
    
    
  
Net change in
        cash and equivalents  447   38,358 
Cash and
        equivalents at beginning of period  66,226   47,814 
    
    
  
Cash and
        equivalents at end of period  $  
          66,673   $  
          86,172 
    
    

        
     

    

    
 

    
See accompanying
      Notes to Condensed Consolidated Financial Statements.

    
 R.R. DONNELLEY
      & SONS COMPANY AND SUBSIDIARIES

    
 

    

    
 

    
CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
For the Three
      Months Ended March 31
(Thousands of
      dollars)
 
     2000
    1999
Cash flows
        provided by (used for) operating activities:      
          Net
        income    $    46,701     $    43,980 
          Loss
        from discontinued operations, net of tax    —      1,820 
         
         Depreciation    80,509     79,328 
         
         Amortization    14,378     12,234 
          Gain
        on sale of assets    (4,976)    (2,985)
          Net
        change in operating working capital    (85,287)    (43,771)
          Net
        change in other assets and liabilities    8,074     18,459 
         
         Other    (3,552)    1,862
    
    
  
Net Cash
        Provided by Operating Activities    55,847     110,927 
    
    
  
Cash flows
        provided by (used for) investing activities:        
         
         Capital expenditures    (56,101)     (64,393)
         
         Other investments including acquisitions, net of cash
        acquired    (207,343)    (52,465)
         
         Dispositions of assets    5,222     —  
    
    
  
Net Cash Used
        For Investing Activities     (258,222)    (116,858)
    
    
  
Cash flows
        provided by (used for) financing activities:        
          Net
        increase in borrowings    256,042    166,450 
         
         Issuances of common stock    860     1,464 
         
         Acquisition of common stock     (21,361)     (123,559)
          Cash
        dividends paid    (26,926)    (28,017)
    
    
  
Net Cash
        Provided by Financing Activities    208,615     16,338
    
    
  
Effect of
        exchange rate changes on cash and equivalents    157     (1,635)
    
    
  
Net Increase in
        Cash and Equivalents    6,397     8,772 
Cash and
        Equivalents at Beginning of Period    41,873     66,226 
    
    
  
Cash and
        Equivalents at End of Period    $    48,270     $    74,998 
    
    
  
 
See accompanying
      Notes to Condensed Consolidated Financial Statements.
R.R. DONNELLEY
      & SONS COMPANY AND SUBSIDIARIES
 
 
NOTES TO
      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

    
 

    
        NOTE
    1. The condensed consolidated financial statements included herein are
      unaudited (although the balance sheet at December 31, 19981999 is condensed
      from the audited balance sheet at that date) and have been prepared by
      the company to conform with the requirements applicable to this quarterly
      report on Form 10-Q. Certain information and disclosures, normally
      included in financial statements prepared in accordance with generally
      accepted accounting principles, have been omitted as permitted by such
      requirements. However, the company believes that the disclosures made are
      adequate to make the information presented not misleading. These
      condensed consolidated financial statements should be read in conjunction
      with the consolidated financial statements and the related notes included
      in the company’s 19981999 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,
      1999,March 31, 2000, and
      December 31, 1998,1999, were as follows:

    
 


    

     

       
          
      
        (Thousands(Thousands of
      

      Dollars)

     

     

       
          2000
    
      1999
  1998
        

     

     

      Raw materials
        and manufacturing supplies
          
      $124,825122,108
       
          
      $121,490125,014
       
     

     

      Work in
        process
          
      213,467176,386
       
          
      150,775150,992
       
     

     

      Finished
        goods
          
      2,2891,813
       
          
      1,2201,388
       
     

     

      Progress
        billings
          
      (65,07843,848
      )
          
      (42,21739,901
      )
     

     

      LIFO
        reserve
          
      (50,93745,230
      )
          
      (48,33743,181
      )
     

     

        
        
      

        
        
      

        
     

     

               
                  
         Total
        inventories
          
      $224,566211,229
       
          
      $182,931194,312
       
     

     

        
        
      

        
        
      

        
     

     
 
     

               NOTE
        
      3. The following provides supplemental cash flow information:
       
      

        
           
       
         (Thousands(Thousands of
       

       Dollars)

      

      

        
           
       
         NineThree Months
         Ended
       

       September 30March 31

      

      

        
           
       
         19992000

           
       
         19981999

      

      

         
            Interest
         paid
           
       $   44,194 8,077
        
           
       $   44,200 5,693
        
      

      

         
            Income taxes
         paid
           
       $  
         61,45916,367
        
           
       $123,220  10,508
        
      

     

     
 

     
        NOTE
       
     4. On November 25, 1996, a purported class action was brought against the
       company in federal district court in Chicago, Illinois, on behalf of all
       current and former African-American employees, alleging that the company
       racially discriminated against them in violation of the Civil Rights Act
       of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R.
       Donnelley & Sons Co.). The complaint seeks declaratory and
       injunctive relief, and asks for actual, compensatory, consequential and
       punitive damages in an amount not less than $500 million. Although
       plaintiffs seek nationwide class certification, most of the specific
       factual assertions of the complaint relate to the closing by the company
       of its Chicago catalog operations in 1993. Other general claims relate
       to other company locations. On August 10, 1999, the district court judge
       denied the company’s motion for partial summary judgment on the
       basis of timeliness. Discovery is under way.
 

     
R.R. DONNELLEY
       & SONS COMPANY AND SUBSIDIARIES

     
 

     
NOTES TO
       CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

     
 

     

               On December 18, 1995, a
       class action was filed against the company in federal district court in
       Chicago alleging that older workers were discriminated against in
       selection for termination upon the closing of the Chicago catalog
       operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The
       suit also alleges that the company violated the Employee Retirement
       Income Security Act (ERISA) in determining benefits payable to retiring
       or terminated employees. On August 14, 1997, the court certified classes
       in both the age discrimination and ERISA claims limited to former
       employees of the Chicago catalog operations.

     
 

     
        On June 30, 1998,
       a purported 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 contained in
       the Jones complaint, the Adams plaintiffs are also
       claiming retaliation by the company for the filing of discrimination
       charges or otherwise complaining of race discrimination. The complaint
       seeks the same relief and damages as sought in the Jones
       case.

     
 

     
        Both the Jones
       and Gerlib cases relate primarily to the circumstances
       surrounding the closing of the Chicago catalog operations. The company
       believes that it acted properly in the closing of the operations.
       Further, with regard to all three cases, the company believes it has a
       number of valid defenses to all of the claims made and will vigorously
       defend its actions. However, management is unable to make a meaningful
       estimate of any loss that could result from an unfavorable outcome of
       any of the pending cases.

     
 

     
        In December 1999,
       the U.S. Environmental Protection Agency, Region 5 (U.S. EPA) issued a
       Notice of Violation against the company, pursuant to Section 113 of the
       Clean Air Act (the Act). The notice alleges that the company’s
       facility in Willard, Ohio, violated the Act and Ohio’s State
       Implementation Plan in installing and operating certain equipment
       without appropriate air permits. While the notice does not specify the
       remedy sought, upon final determination of a violation, U.S. EPA may
       issue an administrative order requiring the installation of air
       pollution control equipment, assess penalties, or commence civil or
       criminal action against the company. The company responded to U.S. EPA
       on March 10, 2000. The company does not believe that any unfavorable
       result of this proceeding will have a material impact on the
       company’s financial position or results of operations.
 
        In addition, the
       company is a party to certain litigation arising in the ordinary course
       of business which, in the opinion of management, will not have a
       material adverse effect on the operations or financial condition of the
       company.

     
 

     
         NOTE
       
     5. The company has adopted Statement of Financial Accounting Standards (SFAS)
       No. 130, Reporting Comprehensive Income.Income in 1998. This statement
       is intended to report a measure of allreports changes in shareholders’ equity that result from either
       recognized transactions or other economic events, excluding capital
       stock transactions, which impact shareholders’ equity. For the
       company, the only difference between net income and comprehensive income
       iswas the effect of the change in unrealized foreign currency translation
       lossesgains (losses) as follows:

     
 


     

      

        
           
       
         (Thousands(Thousands of 
Dollars)
  
         (Thousands of
       

       Dollars)

      

      

        
           
       Three Months
       

       Ended
       

       September 30,
  
         Nine Months Ended
       

       September 30,March 31

      

      

        
           
       
         19992000

           
       1998
  1999
  
         1998

      

      

       Net
         income
           
       $85,587 46,701
           
       $  
         99,24343,980  $182,053   $202,187
        
      

      

       Unrealized
         foreign currency gain (loss)
           
       (4,230)4,973
         5,665   
       (12,3647,288)  (6,863
       )
      

      

         
           
       
  
         
  
   
         

         
      

      

       Comprehensive
         income
           
       $81,357 51,674
           
       $104,90836,692  $169,689   $195,324
        
      

      

         
           
       
  
         
  
   
         

         
      

     
 
R.R. DONNELLEY
       & SONS COMPANY AND SUBSIDIARIES
 
NOTES TO
       CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

     
 

     

               NOTE 
     6. The company operates inprimarily within the commercial print portion of
       the printing industry.industry, with related service offerings designed to offer
       customers complete solutions for communicating their messages to target
       audiences. Substantially all revenues within commercial printing result
       from the sale of printed products and services to customers in the
       following markets:end-markets: Long-Run Magazines, Catalogs and Inserts; Book
       Publishing Services,Services; Financial Services, MagazineServices; Telecommunications; Short-Run
       Magazines and Catalogs (served by our Specialized Publishing Services
       Merchandise Mediaoperation); and Telecommunications.International, which provides similar products and
       services. The company’s management has aggregated its commercial
       print businesses as onePremedia services, which include capturing
       content, converting it to the appropriate format and channeling it to
       multiple communications media, are included within the reportable
       segment because of strong
       similarities in the economic characteristics, nature of products
       and services, production processes, class of customer and
       distribution methods used. The
     company’s investment in businesses held for sale has been
       disclosed as a separate reportable segment, as the revenues
       generated from these businesses are unrelated to the commercial
       printing industry—refer to “Businesses Held for Sale
       Commercial Print” and “Subsequent Events” under Item 2 of this
       Form 10-Q for additional information..

     
 

     
        R.R. Donnelley
       Logistics Services (Donnelley Logistics) represents the company’s
       logistics and distribution services operation for its print customers
       and other mailers. Donnelley Logistics serves its customers by
       consolidating and delivering printed product and parcels to the U.S.
       Postal Service closer to the final destination, thereby resulting in
       reduced postage costs and improved delivery performance. Following the
       company’s acquisition of certain net assets of CTC Distribution
       Services LLC (CTC) in February 2000, the combined operations of
       Donnelley Logistics and CTC are now included within the reportable
       segment “Logistics Services” for the quarter ended March 31,
       2000. Prior year amounts have also been restated to reflect the current
       year presentation. Refer to Note 8 for additional information regarding
       the acquisition of CTC.
 
        In connection
       with the acquisition of CTC, the company has changed its presentation of
       reported operating results for Donnelley Logistics. Previously, net
       sales of Donnelley Logistics were classified net of transportation
       costs. For the quarter ended March 31, 2000, the company reported net
       sales for Logistics Services on a gross basis, without deducting
       transportation costs. Cost of sales for Logistics Services now includes
       the cost of transportation. The effect of this change for the quarter
       ended March 31, 1999, was to increase both net sales and cost of sales
       by $52 million; there was no impact on gross profit or earnings (loss)
       from operations.
 
        Since the date of
       acquisition, Logistics Services’ operating results include net
       sales from CTC of $65 million and a loss from operations (and loss from
       continuing operations before income taxes) of $2.3 million.
 
        The company has
       disclosed earnings (loss) from operations as the primary measure of
       segment earnings (loss). This is the measure of profitability used by
       the company’s chief operating decision-maker that is most
       consistent with the presentation of profitability reported within the
       consolidated financial
     
statements. The accounting policies of the business segments reported are
       the same as those described in the “Summary of Significant
       Accounting Policies” (page F-6(F-6 in the 19981999 Annual Report on Form
       10-K).-.
R.R. DONNELLEY
       & SONS COMPANY AND SUBSIDIARIES

     
 

     
NOTES TO
       CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
 
 
Industry
       Segment Information

     
 


     

      

       In Thousands
         

         
       Commercial
       

       Print

         
       
         BusinessesLogistics
       

       Held for
       

       SaleServices

         
       
         CorporateOther
         (1)

         
       
         OtherCorporate(1)

         
       
         AdjustmentsDiscontinued
       

       Operations (2)(2)

         
       Consolidated
       

       Total

      

      

       ThirdFirst
         Quarter 1999Ended March 31,
       

            2000
Sales
         
       $1,283,371
                   
Net
         sales
         
       $175,0771,188,675  $149,251   $  5,044
        
         
       $    —  
        
         
       $   56,772—  
         
       $1,342,970
Earnings (loss)
         from operations  94,539  (175,077
         606
       )
         
       $1,340,143
         (3,884
       
Earnings from
         operations)
         
       153,6925,092    
               —     2,052   1,946
        
         
       —  
         
         95,141157,690
      

      

       Earnings (loss)
         beforefrom continuing
       

            operations before income taxes		
         
       157,56199,287
         
         
               (648)  (3,838)  (18,864)  —    75,937
Assets  3,087,910  238,888
        
         
       (20,14014,454
       ) 
         
       1,744771,407
        
         
       —  
         
         4,112,659139,165
      

      

        
      

      
 
      

       ThirdFirst
         Quarter 1998Ended March 31,
       

            1999		
      

      

       Sales  $1,224,075
         Net
         sales
         
       $175,3811,107,891  $  62,095   $61,418
        
         
       $        —
           
        
         
       $   50,404   — 
            $1,231,404
Earnings (loss)
         from operations  93,605  1,480
        
         
       $(175,381
         305
       )
         
       $1,274,479
         (3,205
Earnings
         (loss) from
       

            operations		  154,309    
               —     (2,243)  (3,822
       )
         
       —  
         
         91,575148,244
      

      

       Earnings (loss)
         beforefrom continuing
       

            operations before income taxes		
         
       159,41693,617
         
         
               —  1,480
        
         
       (1,780681
       )
         
       (3,46619,945
       )
         
       —  
         74,471
Assets
         
       154,170
 
 
Nine Months
         Ended September 30, 1999
Sales  $3,545,919
         2,963,134
         
       $646,162   $  
             — 36,408
        
         
       $169,210   $(646,162
         )  $3,715,129
         
Earnings
         (loss) from
       

            operations		  340,774  (4,890)  5,974   5,421   — 
         96,950
        
         
       347,279
Earnings
         (loss) before
       

            income taxes		  352,117  (4,890)  (55,966)  4,760   — 
          686,985
        
         
       296,021
Assets  3,237,900
          42,517
         
       191,852   605,773   95,159   (151,270)  3,979,414
         
 
 
Nine Months
         Ended September 30, 1998
Sales  $3,443,751
           $575,581   $  
             —    $160,289   $(575,581
         )  $3,604,040
         
Earnings
         (loss) from
       

            operations		  330,733  (80,067)  5,395   (2,726)  — 
            253,335
Earnings
         (loss) before
       

            income taxes		  347,274  (80,067)   102,372
            (2,417)  — 
            367,162
Assets  3,137,122
           201,184   584,779   93,017   (155,712)  3,860,390
         3,825,994
      

     

     


     

      

       
(1)

       		
        
Represents
         other operating segments of the company.company, including Online Services
         which assists customers in the delivery of content and commerce
         online. First quarter 1999 also includes the results of operations and
         assets of Stream International (refer to “Divestitures” in
         Item 2).

       		
      

     

     
 

      

       
(2)

       		
        
Refer to
         discussion of “Businesses Held for Sale,Discontinued Operations” underin Item 2 of this Form 10-Q, which
         describes the separate presentation of the net assets and results of
         operations of businesses held for sale.discontinued operations.

       		
      

     

     
 

     
        
        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 period for deductions. Without the COLI deduction, the company’s
       effective tax rate for the nine months ended September 30, 1999
       increased to 38.5% from 35% for the same period in 1998,
       excluding the impact of the 1998 Metromail and DESI gains, and
       the 1998 CS&T impairment loss.
 
       
        The Internal Revenue Service (IRS), in its
       routine audit of the company, has disallowed the $34 million of tax
       benefit that resultedresult from the COLI interest deductions claimed by the
       company in its 1990 to 1992 tax returns. The company has challenged this
       position in a formal protest filed with the IRS Appeals
       division.

     
 

     
         On October 19,
       1999, in a case involving a different corporate taxpayer, the U.S. Tax
       Court disallowed deductions for loans against that taxpayer’s COLI
       program. Litigation involving other taxpayers also is also pending in other
       courts. Should the position of the U.S. Tax Court be upheld and applied
       to others, the company could lose an additional maximum of $152 million
       in tax benefits for periods from 1993 through 1998. In addition, should
       all or a portion of the company’s COLI deductions ultimately be
       disallowed, the company would be liable for interest on those amounts.
       The company’s maximum exposure for interest should all prior COLI
       deductions be disallowed is approximately $48$55 million after-tax through
       the
       third quarter of 1999.March 31, 2000.

     
 

     
        The company
       believes that its circumstances differ from those involved in the recent
       Tax Court decision, and has
       established reserves for COLI that it believes to be
       appropriate. However,decision. During the fourth quarter of 1999, however, the
       company is examiningrecorded an additional tax provision of $51 million ($0.40 per
       diluted share) related to COLI. The company will continue to examine its
       position and
       may find it necessarywith respect to change its reserve level based upon the Tax Court opinion and resolution of other
       pending cases. The ultimate resolution of these issues may have a
       material impact on the company’s results of operations and
       financial condition.

     
 

     
         NOTE
       
     8. In April 1999,On February 7, 2000, the company acquired certain net assets of CTC,
       the Communicolor divisionlargest mailer of The Standard Register Company
       (Communicolor). Communicolor, with locationsbusiness-to-home parcels in Newark, Ohio,
       and Eudora, Kansas, is a providerthe U.S., for
       approximately $160 million net of personalization services
       and printer of innovative direct-mail campaigns.cash acquired. CTC, based in
       Minneapolis, Minnesota, has 18 facilities nationwide. The acquisition
       washas been accounted for using the purchase method of accounting.
 
       
        In April 1999, the company issued $200 million The
       purchase price has been allocated based upon estimated fair values at
       date of 6 5/8% debentures due in 2029.
       Proceeds received from the sale were used to reduce outstanding
       commercial paper borrowings incurred for working capital
       purposes and in connection with the financingacquisition, pending final determination of the company
       ’s acquisitions of Communicolor and the financial printing
       unit of Cadmus Communications, with the remainder used for
       general corporate purposes. 
 
       
        NOTE 
     9. In March 1998, Metromail Corporation (Metromail) entered into a
       merger agreement with The Great Universal Stores, P.L.C. (GUS),
       pursuant to which GUS initiated a tender offer for the
       outstanding shares of Metromail. In conjunction with the merger,
       the company committed to sell its remaining 37% interest in
       Metromail to GUS. In April 1998, the company received $297
       million, or approximately $238 million after-tax, for its
       remaining interest in Metromail. The company recognized a
       pre-tax gain of $146 million ($87 million after-tax)acquired balances.
       Goodwill from this transaction.
 
       
        NOTE
     10. In May 1998, Donnelley Enterprises Solutions Incorporated
       (DESI) entered intotransaction of approximately $150 million (based upon
       the preliminary purchase price allocation) is being amortized over a merger agreement with Bowne & Co.,
       Inc. (Bowne), pursuant to which Bowne initiated a tender offer
       to acquire all outstanding shares of DESI. In conjunction with
       the merger, the company committed to sell its remaining interest
       in DESI to Bowne. In July 1998, the company received $45
       million, or approximately $36 million after-tax, for its
       remaining interest in DESI. The company recognized a pre-tax
       gain of $23 million ($14 million after-tax) from this
       transaction.
 
       
        NOTE 
     11. In the second quarter of 1998, the company recorded an $80
       million impairment charge (with no associated tax benefit)
       related to the write-down of goodwill at Corporate Software &
       Technologies (CS&T). CS&T is reported as businesses held
       for sale in the accompanying financial statements—refer to
       “Businesses Held for Sale” and “Subsequent Events
       ” under Item 2 of this Form 10-Q for additional information.
       20
       year period.

     
 

     
 Item
       2

     
 

     
Management’s Discussion and Analysis of Financial
       Condition and Results of Operations

     
 

     
Comparison of
       ThirdFirst Quarter and2000 to First Nine Months ofQuarter 1999 to 1998
       

     
 

     
About the
       Company

     
 

     
         R.R. Donnelley
       & Sons Company is a leading North
       Americanpremier provider of commercial printer andprinting,
       information services company.
       Our company provides services from content management through
       logistics and distributionlogistics. We help our customers communicate
       more efficiently and effectively as they use words and images to inform,
       educate, entertain and sell. In each of our businesses, we use our
       distinctive capabilities to manage and distribute words and images in
       ways that provide the merchandising, magazine, book,
       directory, financial and healthcare markets. In all of these
       areas, the company applies its superior skill, scale and
       technologygreatest value to deliver solutions that efficiently meet customers
       ’ strategic business needs.every customer. Our common stock
       (DNY: NYSE)(NYSE: DNY) has been publicly traded since 1956. At the end of September
       1999,March
       2000, we had approximately 32,00034,000 employees working in our core
       printing operations on four continents. We also had 53have
       55 manufacturing plants with a broad range of capabilities to serve our
       customers.customers’ needs. While 90% of our revenue is generated in the
       United States, we have extended our core competencies into
       selected international markets.markets, 88% of our revenue is currently
       generated in the United States.

     
 

     
         Commercial printingPrinting in the
       United States is a large and fragmented industry and includesthat generates more
       than 50,000 firms that
       employ$150 billion in annual revenue. The commercial printing portion of
       the industry accounts for more than one million people and$80 billion in annual revenue. The
       commercial printing end-markets that we currently serve generate approximately
       $150more
       than $40 billion in annual revenue.

     
 

     
         The segment of commercial printing that we serve generates
       approximately $80 billionWe are first or
       second in annual revenue. Within this
       segment, we have leadership positionsrevenue in all five of our end
       markets:primary
       end-markets:
 
        Long-Run
       Magazines, Catalogs and Inserts—serving the consumer and
       business-to-business catalog, magazine, and advertising
       markets;
 
        Book
       Publishing Services—serving the trade, children’s,
       religious, professional and educational book markets;
 
        Financial
       Services—serving the global communication needs of the
       financial markets and mutual fund companies, as well as the banking,
       insurance and health care industries;
 
       
        Telecommunications—serving the global directory needs
       of telecommunications providers; and
 
        Specialized
       Publishing Services—serving the needs of publishers of
       short-run magazines and catalogs.
 
        Given the
       competitive nature of the U.S. commercial printing industry, our intent
       is to differentiate ourselves based on our service offerings. Our
       related services, designed to offer our customers complete solutions for
       communicating their messages to target audiences regardless of the means
       of distribution, include:
 
       
        Premedia—capturing content, converting it to the
       appropriate format and channeling it to multiple communications media,
       including print and the Internet;
 
        Online
       Services—helping customers effectively leverage the Internet
       and their established brands by delivering content and commerce online;
       and
 
        Logistics
       Services—delivering parcels and printed products, primarily via
       the U.S. Postal Service, more efficiently, saving significant amounts of
       time and money.
 
        We believe print
       is a vital component of the communications process and expect the print
       market to grow due to its unique capabilities, such as portability and
       high-quality graphics that cannot be duplicated by other communications
       methods. In addition, we see opportunities to create and expand
       complementary businesses that leverage our core competencies and help
       our customers succeed.
 

               Our objective is to
       create above-average shareholder value through our strategies
       to:

     
 


     

      

       
       
·

       		
        
Magazine Publishing Services, serving the consumer,
         trade and specialty magazine markets;transform our
         core printing businesses;

       		
      

     

     
 


     

      

       
       
·

       		
        
Merchandise Media, serving the consumerspeed growth in
         our high-value businesses; and
         business-to-business catalog, retail insert and direct mail
         markets;

       		
      

     

     
 


     

      

       
       
·

       		
        
Telecommunications, servinglogically
         extend into complementary businesses.
 
        The new business
       opportunities that we pursue will leverage our established strengths and
       will further our goal of managing and distributing words and images to
       help our customers succeed in informing, educating, entertaining and
       selling.
 
        Our distinctive
       capabilities include:
 
·
relationships
         with customers who are the global directory needs
         of telecommunications providers;leaders in their respective
         industries;

       		
      

     

     
 


     

      

       
       
·

       		
        
Book Publishing Services, serving the trade, children
         ’s, religiousa reputation
         for quality and educational book markets; andservice;

       		
      

     

     
 


     

      

       
       
·

       		
        
Financial Services, servingstanding as a
         trusted, neutral partner who recognizes the communication needscritical importance of
         protecting the financial marketsconfidentially of customer content;
 
·
expertise in
         handling digital content;
 
·
scale to
         partner with best-of-class providers and healthcare industry.deliver economical solutions
         for our customers; and
 
·
technology to
         seamlessly help our customers deliver their messages through various
         communications channels.

       		
      

     

     
 

     
        In addition to
       our U.S. operations, we operate in Mexico, South America, Europe and
       China. For reporting purposes, revenues from our international facilities in China and
       England serving primarily serving the directory market are reported within
       Telecommunications. Revenues fromOne of our twofacilities in Mexico facilities that primarily serve the
       magazine market are reported within Magazine Publishing
       Services. Our third Mexico facility serves the book
       market and is reported within Book Publishing Services. RevenuesRevenue from our
       other internationaltwo facilities servingin Mexico that serve primarily the magazine market,
       as well as revenues from our facilities in Poland and South America,
       which serve more than one market, are included in “Other.”International. The
       “Other” classification alsowithin Commercial Print includes net
       sales from R.R. Donnelley
       Logistics Services (DLS), our logisticsPremedia and distribution
       operation. DLS serves our print services customersRRD Direct, which supplies direct mail products
       and others by
       consolidating and sorting mail so that it is delivered to the
       postal system closer to the final destination, resulting in
       reduced postage costs and improved on-time delivery.
       Additionally, DLS delivers magazine newsstand, newspaper inserts
       and financial services products. Finally, revenue from Stream
       International Inc., which provides technical and help-line
       computer support to its customers, is included in “Other.
       ”services.

     
 

     
         While our
       printingmanufacturing plants, financial service centers and sales offices are
       geographically diverse,located throughout the United States and selected international markets,
       the supporting technologies and knowledge base are shared.common. Our plantslocations
       have a range of production capabilities to serve the five
       basic commercial print markets outlined earlier.our customers and
       end-markets. We manufacture products for these markets with the operational goal of
       optimizing the efficiency of ourthe common manufacturing and distribution
       platform. As a result, most plants produce work for customers in two or
       morethree of our end markets.end-markets.
 
        
        Sales results by business unit for the third quarter and
       first nine months of 1999 and 1998 are presented below:

     
 

     
Net Sales by
       Business UnitEnd-Market

     
 


     

      

       ThirdFirst
         Quarter Ended September 30,March 31
       

       (Thousands of Dollars)

           
       19992000

           
       % of
          Total

           
       19981999

           
       % of
          Total

      

      

       Magazine
         Publishing ServicesLong-Run
         Magazines, Catalogs and Inserts
           
       $     288,212451,008 
           
       22%33.6%
           
       $     290,536442,894 
           
       23%36.0%
      

      

       Merchandise
         Media  332,700  25%  330,852  26%
Telecommunications
           
       212,367210,120
         16%
           
       198,61515.6%
           
       16%207,588     16.9%
      

      

       Book Publishing
         Services
           
       211,295182,032
         16%
           
       203,88213.6%
           
       16%170,019     13.8%
      

      

       Financial
         Services
           
       167,156136,109
         12%
           
       133,55510.1%
           
       10%131,254     10.6%
International    82,235     6.1%    59,340     4.8%
Specialized
         Publishing Services    62,987     4.7%    47,544     3.9%
      

      

       Other
           
       128,41364,184
         9%
           
       117,0394.8%
           
       9%49,252     4.0%
      

      

         
         
       
  
  
  
   $1,340,143
           100%  $1,274,479
           100%

         
         
       
  
  
  
 
Nine Months
         Ended September 30,
       

       (Thousands of Dollars)
  1999
  % of
          Sales
  1998
  % of
          Sales
Magazine
         Publishing Services
         
       $  
           840,486  

         
       23%  

         
      
$  
           855,050Total
         Commercial Print
           
       24%1,188,675     88.5%    1,107,891     90.0%
      

      

       Merchandise
         MediaLogistics
         Services
           
       873,732  149,251
       24% 
           
       891,030  11.1
       25%

         Telecommunications%
           
       612,863  62,095
       16% 
           
       564,146  5.0
       16%
Book
         Publishing Services  558,621  15%  550,680  15%
Financial
         Services  471,889  13%  405,952  11%%
      

      

       Other
           
       357,5385,044
         9%
           
       337,1820.4%
           
       9%61,418     5.0%
      

      

         
         
       
  
  
  
 
         
       $3,715,129
           

         
       100%   
       $3,604,040
         

         
       100%  
  
Total Net
         Sales    $1,342,970     100.0%    $1,231,404     100.0%
      

      

         
         
       
  		
         
         

         
       
  		
         
           
  
Cost of
         materials    (463,384)         (429,014)    
Cost of
         transportation    (122,078)        (48,999)    
    
          
        
         
          Total Value-Added Revenue    $    757,508          $    753,391     
    
          
        
      

     

     
 

     
Consolidated
       Results of Operations
 
       
        Net income for the third quarter of 1999 was $86 million,
       or $0.67 per diluted share, compared to net income of $99
       million, or $0.71 per diluted share for the prior year third
       quarter. Third quarter 1998 included a $14 million after-tax
       gain on the sale of DESI ($0.10 per diluted share). Excluding
       the effect of this one-time item, net income for the third
       quarter of 1998 was $85 million, or $0.61 per diluted share.
       
 
       
        Net income for the first nine months of 1999 was $182
       million, or $1.39 per diluted share, compared to net income of
       $202 million, or $1.41 per diluted share for the prior
       year-to-date period. The first nine months of 1999 included an
       after-tax loss from businesses held for sale of $3 million
       ($0.02 per diluted share). The first nine months of 1998
       included an $87 million after-tax gain on the sale of Metromail
       ($0.61 per diluted share), a $14 million after-tax gain on the
       sale of DESI ($0.10 per diluted share), and an $80 million
       after-tax loss from businesses held for sale ($0.56 per diluted
       share). Excluding the effects of these one-time items, net
       income for the first nine months of 1999 was $185 million, or
       $1.41 per diluted share, compared to net income of $181 million,
       or $1.26 per diluted share in 1998. Excluding the impact of the
       1998 Metromail and DESI gains and the $80 million after-tax loss
       from businesses held for sale noted above, the overall effective
       tax rate increased in 1999 to 38.5% from 35% in 1998 due to the
       phase-out of deductions for the company’s corporate-owned
       life insurance programs (COLI). Diluted earnings per share for
       1999 also reflect the effects of the company’s share
       repurchase programs.
 
Consolidated Net Sales

     
 

     
         Net sales forFor the thirdfirst
       quarter, we reported net income from continuing operations of $47
       million in 2000, or $0.38 per diluted share, compared with net income
       from continuing operations of $44 million in 1999, or $0.34 per diluted
       share. Earnings per diluted share of $0.34 in the first quarter of 1999
       including
       materials such as paper and ink, increased $66 million, or 5%included a $0.01 favorable impact from a year ago, despite lower paper prices and fewer
       pass-through materials sales. Paper prices across our Magazine
       Publishing Services and Merchandise Media markets have declined
       more than 10%Stream International (Stream);
       refer to “Divestitures”. The first quarter effective tax rate
       for both years was 38.5%. The 12% increase in earnings per share from
       continuing operations reflected the previous year. In severalbenefit of our markets,
       but primarily Magazine Publishing and Merchandise Media, the
       proportion of customer-supplied paper has increased in 1999
       resulting in
     fewer pass-through materials sales. The acquisitions of Cadmus
       Financial and Communicolor contributed $26 million inshare repurchase
       activity, as well as higher net sales
       for the third quarter of 1999. Third quarter 1999 sales net of
       materials increased $65 million, or 8%income from a year ago, which
       reflected our emphasis on higher value-added products and
       services.continuing
       operations.

     
 

     
         ThirdEarnings from
       operations increased 4% to $95 million in the first quarter of 2000. For
       comparative purposes, earnings from operations excluding Stream in 1999
       increased 6% for the first quarter of 2000. This increase was due to the
       strength of our core commercial print operations during the first
       quarter of 2000, as well as lower administrative expenses from reduced
       Year 2000 expenditures. Higher interest expense during the first quarter
       of 2000 reflected our increased borrowings to fund acquisitions and
       working capital.
 
        First quarter
       1999 consolidated earnings per share of $0.33 included a ($0.01) loss
       from discontinued operations (refer to “Discontinued
       Operations”).
 
Consolidated
       Net Sales and Value-Added Revenue
 
        Net sales, which
       includes materials such as paper and ink, increased $112 million in the
       first quarter of 2000, or 9% from a year ago. First quarter net sales
       for the combined commercial
       printCommercial Print segment were up 7% from a year ago. The level
       of net sales, particularly for our Long-Run Magazine, Catalogs and
       Inserts market, is impacted by the amount of pass-through material
       sales. First quarter net sales for Long-Run Magazine, Publishing ServicesCatalogs and
       Merchandise
       MediaInserts increased 2% from the prior year, which reflected volume
       increases across all major markets, offset in part by lower pass-through
       material sales. Paper prices during the first quarter of 2000 for major
       grades of paper employed within the Long-Run Magazine, Catalogs and
       Inserts market were up approximately 1% from a year ago. First quarter
       net sales for Telecommunications were essentially flat compared towith the
       prior year, as an increase in directory volumes was offset by a
       reduction in non-directory volumes. Book Publishing Services’ first
       quarter net sales increased 7%, primarily reflecting higher volumes
       within the consumer and educational markets. Financial Services’
       first quarter net sales were up 4% from a year ago, despiteprimarily due to the
       strength of its international operations. Financial Services’
       domestic net sales were negatively impacted by a slowdown in capital
       markets activity late in 1999 due to Year 2000 concerns, which affected
       early first quarter billings, and greater overall market volatility.
       Capital market billings rebounded by March 2000.
 
        First quarter net
       sales in 2000 for the Logistics Services segment more than doubled from
       a year ago, primarily due to the acquisition of CTC on February 7, 2000
       (refer to Note 8). Since the date of acquisition, CTC has contributed
       approximately $65 million in net sales. As discussed in Note 6, first
       quarter net sales in 1999 for Donnelley Logistics have been restated to
       reflect sales on a gross basis, before deducting transportation
       costs.
 
        For comparative
       purposes, first quarter net sales in 1999 included approximately $59
       million of sales related to Stream, which we divested in the fourth
       quarter of 1999 (refer to “Divestitures”).
 
        The price of
       paper can be volatile. In periods of rising prices, our net sales and
       cost of materials increase; in periods of falling prices, our net sales
       and material costs decline. For some customers, we purchase paper and
       pass through this cost at a margin that is lower than print and other
       related-services; other customers furnish their own paper.
       Customer-furnished paper is not included in our financial results. With
       respect to Logistics Services, transportation costs are passed through
       to our customers and therefore are included in our net sales.
       Value-added revenue represents net sales, less the cost of materials
       (principally paper and ink), and less the cost of transportation related
       to Logistics Services. Value-added revenue eliminates the effects of
       material prices and more customer-supplied paper. Merchandise Media
       net sales for the third quarter included $20 million from
       Communicolor. Book Publishing Services net sales increased 4%
       for the third quarter due to higher base volumes, partially
       offset by lower fulfillment and distribution revenues. Net sales
       for Telecommunications increased 7% for the third quarter,
       driven primarily by higher directory and non-directory volumes.
       Net sales for Financial Services increased 25% for the third
       quarter, related primarily to market share gains in the capital
       markets and higher international volume.transportation costs that are largely beyond our
       control.

     
 

     

               For the first nine monthsquarter of
       1999, net sales, including
       materials such as paper and ink,2000, value-added revenue increased $111 million, or 3%1% from a year ago, despite lower paper prices and fewer
       pass-through materials sales. For the first nine months ofago; excluding Stream
       in 1999, paper prices were down over 10%value-added revenue increased 9% from a year ago across the
       Magazine Publishing Services and Merchandise Media markets. The
       acquisitions of Cadmus and Communicolor contributed $55 million
       in net sales for the first nine months of 1999. Sales net of
       materials increased 7% for the first nine months of 1999,
       reflecting our emphasis on higher value-added products and
       services.
 
       
        For the first nine months of 1999, net sales for the
       combined Magazine Publishing Services and Merchandise Media
       markets decreased 2% from a year ago, which reflected lower
       paper prices and a shift to more customer-supplied paper,
       partially offset by higher volumes. Net sales for
       Telecommunications increasedago. Of this 9%
       for the first nine months of
       1999 primarilyincrease excluding Stream, 5% was due to higher volume and timing shifts from the
       fourth quarter of 1998. Book Publishing Services net sales
       increased 1% for the first nine months of 1999, as the effect of
       volume increases from the strong education and one-color markets
       was largely offset by lower fulfillment and distribution
       revenues. Financial Services net sales for the first nine months
       of 1999 increased 16%, related primarily to volume increases,
       driven by our strong performance in capital markets and
       increased international activity.acquisitions.

     
 

     
Consolidated
       Expenses

     
 

     
         Gross profit for
       the thirdfirst quarter of 1999 increased2000 fell by 9%1% to $322$241 million, compared to $294with $243
       million for the same period
       last year. Third quarter grossa year ago. Gross profit as a percentage of net sales increasedfell to
       24.0%17.9% from 23.1% a year ago. Gross profit for the
       first nine months of 1999 increased by 9% to $824 million
       compared to $753 million last year, and gross profit as a
       percentage of sales increased to 22.2% from 20.9%19.7% a year ago. The increaseLogistics Services segment, which
       reflects lower gross margins than commercial print, represented a higher
       proportion of consolidated net sales in the first quarter of 2000 (11%
       versus 5% a year ago). The decrease in gross margin for both the third quarterwas also due to a
       decrease within Financial Services because of a slowdown in domestic
       capital markets activity. Within our core commercial print operations
       (Long-Run Magazines, Catalogs and first nine months of 1999 reflected primarily the resultsInserts, as well as Book Publishing
       Services) we continued to realize productivity improvements as a result
       of our continued productivity initiatives. As of September 30, 1999, we
       have implemented specific productivity improvement plans at 26
       of our manufacturing facilities. The initiatives are targeted
       toward making our operations more productive by analyzing all
       aspects of the production process.emphasis on Process Variability Reduction and Six Sigma
       application and training.

     
 

     
         Selling and administrative expenses forCost of materials
       is impacted by the thirdprice of scrap (by-product) paper that we sell.
       Income from the sale of by-products is recorded as a reduction in our
       cost of materials. For the first quarter of 1999 increased 12% to $1642000, we recognized a
       reduction in our cost of materials of $16 million or 12.2%from the sale of
       sales
       compared to 11.4% forby-products, which doubled from the priorfirst quarter a year period. Of the 12%
       increase, 5% wasago, primarily
       as a result of the impact of recent acquisitions,
       and the remainder was due primarily to increased Financial
       Services volume and building enhanced capabilities within paper
       services and corporate-wide strategy.higher by-products prices.

     
 

     
         Selling and
       administrative expenses for the first nine
       monthsquarter of 1999 increased2000 fell by 12%4%, or $5
       million, to
     $472

     $146 million, or 12.7%which represented 10.9% of net sales compared to 11.6% last year. Of the 12% increase, 4%with 12.3% a
       year ago. The first quarter 2000 decline was primarily a result of lower
       Year 2000-related expenses ($10 million), and the impactelimination of Stream
       expenses ($15 million—refer to “Divestitures”), partially
       offset by recent acquisitions ($8 million) and the remainder
       was due primarily to increased Financial Services volumeadditional information
       technology and upgrading our capabilities as noted above.growth-related expenditures.

     
 

     
Summary of
       Expense Trends

     
 


     

      

       ThirdFirst
         Quarter, Ended September 30,March 31,
                     
       
         1999%Increase
  
         1998
  % Increase
       

       (Decrease)

      

      

       (Thousands
         of Dollars)

           
       2000

           
       1999

           
       (Decrease)

      

      

       Cost of
         materials
           
       $  
           478,455463,384
           
       $  
           478,068429,014
           
       0.08%8.0%
Cost of
         transportation
           122,078    48,999    149.1%
      

      

       Cost of
         manufacturing
           
       443,375421,598
           
       406,781418,893
           
       9.00%0.6
       %
      

      

       Depreciation
           
       83,03880,509
           
       80,30379,328
           
       3.41%1.5
        %
      

      

       Amortization
           
       13,62014,378
           
       15,30712,234
           
       (11.02%17.5
       )%
      

      

       Selling and
         administrative
           
       163,965145,882
           
       145,776151,361
           
       12.48%(3.6
        %)
      

      

       Net interest
         expense
           
       23,084  19,400  18.99%
 
 
Nine Months
         Ended September 30,  
         1999
  
         1998
  % Increase
       

       (Decrease)
(Thousands
         of Dollars)
  
  
  
Cost of
         materials22,141
           
       $1,324,519
         19,896
           
       $1,360,153
         11.3
         (2.62%)
Cost of
         manufacturing  1,288,254
           1,210,626
           6.41%
Depreciation
           242,358  242,272  0.04% 
Amortization
           36,158  38,162  (5.25%)
Selling and
         administrative  471,671  419,425  12.46% 
Net interest
         expense  66,705  59,036  12.99% %
      

     

     
 

     
Non-operatingNonoperating
       Items

     
 

     
         Interest expense increased $4 million for the quarter and
       $8 million
       for the first nine monthsquarter of 19992000 was approximately $22 million, up $2
       million from a year ago due to higher average debt levels related toassociated with recent
       acquisitions and share
       repurchase activity.increased working capital.

     
 

     
         Other income,
       net, for the first quarter of 2000 was $2.9 million, which is comparable
       to a year ago and reflected a gain on the sale of real estate ($4.5
       million), offset in part by lower earnings from equity-based
       investments. In 1999, other income, net, reflected a gain of $3 million
       on the thirdsale of real estate.
 
Discontinued
       Operations
 
        In the first
       quarter of 1999, was $5.0we recorded a pretax loss from discontinued operations
       of $3 million ($2 million after-tax) related to our remaining 86%
       investment in Corporate Software & Technology (CS&T), a software
       distribution business. Our ownership interest in CS&T resulted from
       the restructuring of our 80%-owned investment in Stream International
       Holdings, Inc. (SIH) in December 1997. In addition to CS&T, SIH held
       investments in Stream, which provided outsource technical support
       services, and exceededModus Media International (MMI), a manufacturing and
       fulfillment business (refer to “Divestitures”). As of December
       1997, we had converted our equity and debt positions in CS&T to 86%
       of the prior year third quarter by
       approximately $2.0 million due to lower COLI expense ($1.0
       million) and other miscellaneous net non-operating gains.common stock of CS&T.

     
 

     

               In April 1998,November 1999, we
       sold our remainingentire interest in Metromail. We received $297 million inCS&T to the management of CS&T for
       cash proceeds of approximately $41 million. We did not recognize any
       gain or approximately $238 million after-tax, and recognized a pre-tax
       gain of $146 million ($87 million after-tax) on this
       transaction. In July 1998, we sold our remaining interestloss from the sale in DESI. We received $45 million, or approximately $36 million
       after-tax, and recognized a pre-tax gain of $23 million ($14
       million after-tax) on this transaction.1999.

     
 

     
Businesses Held for SaleDivestitures

     
 

     
         During 1996, Stream International Holdings, Inc. (SIH), an
       80%-owned equity investment ofAt the company, reorganized into
       three independent businesses: Stream International, which
       provides outsource technical support services; Corporate
       Software & Technology (CS&T), a software distribution
       company; and Modus Media International (MMI), a global
       manufacturing and fulfillment business.
 
       
        On December 15, 1997, SIH’s businesses became
       separate companies andtime our
       ownership interest in SIH was restructured. Werestructured in December 1997, we
       converted our equitydebt and debtequity positions in Stream International into 87% of the common
       stock of that business and converted our equity and debt positions in CS&T
       into 86% of the common stock of CS&T. Additionally, we sold our equity and debt positions in MMI for
       non-votingnonvoting preferred stock of MMI. In connection with the planned disposition of CS
       &T, we have reported our interest in CS&T as businesses
       held for sale.

     
 

     
         At the timeIn November 1999,
       we sold 93% of our ownership interests were restructured in
       December 1997, we had prepared a formal plan of disposition to
       sell the entire CS&T business as a going concern, which we
       had expected to execute within twelve months. By the second
       quarter of 1998, intensified competition had negatively impacted
       both current operating results and our valuation of CS&T.
       Accordingly,investment in the second quartercommon stock of 1998, we recorded an $80Stream to a group
       led by Bain Capital for approximately $96 million impairment charge (with no associatedin cash. We recognized
       a pretax gain of $40 million and a tax benefit)
       relatedbenefit of $35 million (total of
       $75 million after-tax) from this transaction. The tax benefit in 1999
       was recognized because of our ability to carry back the writedown of goodwill at CS&T. As of December 1998,capital tax
       losses generated from the
       net assets and results of operations of businesses held for sale
       were reclassified from discontinued operations because the
       planned sale of CS&T did not occurStream to years 1996 through 1998. We
       now have a 6% investment in 1998 as originally
       intended. The netStream, representing the remaining 7% of our
       original 87% interest, that has been reflected in other noncurrent
       assets of CS&T are included in net assets
       of businesses held for sale as of September 30, 1999March 31, 2000 and December 31, 1998. Our investment1999. For reporting
       purposes, Stream was consolidated in the non-voting preferred
       stock of MMI at both September 30, 1999 and December 31, 1998 is
       included in other non-current assets.-our financial results until
       November 1999.

     
 

     
         For comparison
       purposes, our 87% ownership interest in Stream for the first nine months ended September 30,quarter of
       1999 we
       recorded a $5represented approximately $59 million ($3.0in net sales/value-added
       revenue, $17 million after-tax) lossin gross profit, and $2 million in income from
       operationsoperations. The impact on net income for the first quarter of businesses held for sale.1999 from
       Stream was approximately $1 million, or $0.01 per diluted
       share.

     
 

     
         On September 30, 1999, CS&T entered into an Agreement
       and Plan of Merger pursuant to which the management of CS&T
       will acquire CS&T. Upon closing, which is anticipated in
       NovemberIn October 1999,
       we expect to receivesold our remaining investment in nonvoting preferred stock of MMI for
       approximately $40.4$60 million ($47 million in cash proceeds in exchange for our entire interest in CS&T.
       and a $13 million
       promissory note due no later than October 2002). The promissory note is
       interest-bearing at 9.5% per annum, payable quarterly. We recognized
       both a pretax and after-tax gain of $3 million from this
       transaction.

     
 

     
         Summary financial informationAs a result of
       businesses held forthese divestitures and the sale has been disclosed withinof CS&T (refer to “Discontinued
       Operations”), we generated approximately $77 million in refundable
       income taxes from the “Industry Segment Information
       ” (Note 6carryback of the Notestax losses, expected to Condensed Consolidated Financial
       Statements includedbe received
       in Part I of this Form 10-Q). See “
       Subsequent Events” under Item 2 of this Form 10-Q for
       additional information relating to Stream International and MMI.
       2000.

     
 

     
Changes in
       Financial Condition

     
 

     
Liquidity and
       Capital Resources

     
 

     
         Net cash provided
       by operating activities forin the first nine monthsquarter of 19992000 totaled $399$56
       million, down $63$55 million from a year ago, primarily due primarily to a higher
       investment in operating working capital in 1999.capital. The increase in operating
       working capital in 1999 was driven primarily by increased inventory levelshigher receivables and
       inventories to support higherincreased sales volumes, and higher accrued compensation
       payments. Cashflow from operations in 1999 was also negatively
       impacted by payment of $22 million in the third quarter for
       settlement of claims made by the U.S. Attorney and the U.S.
       Postal Service related to postage due for reorders over a
       10-year period ending August 1999.volume.

     
 

     
         Capital
       expenditures forin the first nine monthsquarter of 19992000 totaled $198$56 million compared
       to $159with $64 million for the first nine
       months of 1998.a year ago. Spending was directed principally to
       projects
       that further enhance productivity and to upgrade our systems
       infrastructure and capabilities companywide.investments in productivity. Full-year 2000 capital spending is expected
       to approximaterange from $300 to $350 million in 1999 in support of selected growth opportunities,
       including the opening
       of a new telephone directory plant in Brazil and expansion of our Poland operations. Management believes thatoperations, a new directory plant in
       York, England, as well as investments to standardize and upgrade systems
       company-wide.
 
        In February 2000,
       we purchased CTC, which approximately doubled the company’
       s cash flowsize of our Logistics
       Services business and borrowing capacity are sufficientexpanded our distribution capabilities (refer to
       fund
       current operationsNote 8). During the first quarter of 2000, we also acquired Dallas-based
       Omega Studios, known for producing high-quality digital photography,
       turnkey creative concept, layout design and growth.desktop publishing services;
       the Florida financial printer EVACO; and the Seattle-based premedia
       provider Iridio, Inc. In addition, we invested in Noosh, Inc., a
       business-to-business Internet-based service designed to improve the
       process of buying, selling and managing print.

     
 

     

               In the current quarter, we acquired the net assets of a
       California-based transportation company, Freight Systems Inc.,
       and a 30% equity investment in an Internet website design firm,
       Multimedia Live. InMarch 1999, we
       also acquired the net assets ofpurchased the financial printing unit of Cadmus FinancialCommunications. The
       purchase included the assets and operations of five service centers in
       March 1999, the
       net assets of the Communicolor division of The Standard Register
       CompanyBaltimore, Charlotte, Raleigh, Richmond and New York, as well as a
       print-on-demand and fulfillment facility in April 1999,Charlotte and the net assets of the Brazilian book
       printer Hamburg Gráfica Editora in May 1999, and purchased
       our partner’s 50% interest in the Argentinian printer Atl
       ántida in June 1999.selected
       software products.

     
 

     
         In April 1999, we issued $200Net borrowings
       during the first quarter of 2000 increased $90 million of debentures
       primarilyover the same
       period for the prior year to finance recent acquisitions and the completion of the
       share repurchase program we announced in September 1998.working
       capital needs. At September 30, 1999,March 31, 2000, we had an unused revolving credit
       facility of $400 million with a number of banks. This credit facility
       provides support for the issuance of commercial paper and other credit
       needs.

     
 

     
Subsequent EventsYear 2000 and
       System Infrastructure

     
 

     
       
        On October 7, 1999, Stream International entered into a
       merger agreement pursuant to which our 87% interest in Stream
       will be reduced to 6%, and we will receive approximately $94
       million in cash proceeds. The transaction is expected to close
       in November 1999.
 
        
        On October 13, 1999, we sold our remaining investment in
       MMI, which consisted of 9.50% Series Senior Cumulative Preferred
       shares, for a total of $60.2 million ($47.5 million in cash and
       a $12.7 million promissory note due no later than October 13,
       2002). The promissory note due from MMI has an annual rate of
       interest of 9.5%, payable quarterly. We will recognize a pre-tax
       gain of $2.6 million on this transaction.
 
       
        During October 1999, we paid $18 million to acquire an
       additional 20.65% interest in Editorial Lord Cochrane S.A.
       (Cochrane). This purchase increased our ownership percentage in
       Cochrane from 78% to 99%.
 

     Year 2000
 
       
        Process control
       and information systems are increasingly important to the effective
       management of the company. Increased
       spending on newThe upgrade and standardization of our
       systems and updating of existing systems
       continuesis necessary for us to be necessary. We recently havesucceed in using information technology
       to our strategic advantage. In 1999, we focused theseour efforts on ensuring
       that processes and systems arewere Year 2000 compliant. In addition, the company has been engaged in an
       initiativewe
       began ongoing initiatives to upgrade and standardize our information
       technology infrastructure, which has the incidental effect of addressing
       certain of the company’s Year 2000 compliance issues. We
       haveinfrastructure. In 1999, we deferred a number of other
       infrastructure and systems initiatives that would support continuous
       productivity improvements and enhancedenhance service capabilities, pending
       completion ofwhile we
       completed our Year 2000 efforts.

     
 

     
         TheDuring the
       transition from 1999 to 2000, all operations were fully supported by
       trained personnel. Key efforts were focused on four business-critical
       factors: safety of employees, continuity of production, environmental
       compliance and reporting, and continuity of systems to support the
       ability of personnel to continue working (such as the availability of
       utilities or operation of payroll systems). At the end of the
       transition, no Year 2000 complianceissues affecting any business-critical factors
       were reported by any operation. To the extent that date-related issues
       were reported, they were limited to instances where personnel available
       at the site were able to promptly correct the issue stems from the computer
       industry’s practice of conserving data storage by using two
       digitswithout disruption
       to represent a year. Systems and hardware using this
       format may process data incorrectly or fail with the use of
       dates in the next century. These types of failures can influence
       applications that rely on dates to perform calculations (such as
       an accounts receivable aging report), as well as facility
       systems (such as building security and heating) and
       manufacturing equipment.our operations.

     
 

     
         The company’s efforts to address YearFor the first
       quarter of 2000, compliance
       issues in our core business include:
 
·
         

         evaluating internal computing infrastructure, business
         applications and shop-floor systems for Year 2000 compliance,
         
 
·
         

         replacing or renovating systems and applications as necessary
         to assure such compliance, and
 
·
         

         testing the replaced or renovated systems and applications.
         
 
       
        Our efforts in these respects are substantially complete.
       All but two low-priority business applications have been
       renovated, tested and redeployed, and the remaining applications
       will be redeployed during November 1999. Solutions have been
       deployed to address more than 98% of the 2,000 non-compliant
       shop-floor systems in use throughout the United States and other
       locations, and contingency plans have been developed to address
       any remaining system issues. Our infrastructure compliance work,
       including replacement of non-compliant equipment, is nearly
       complete, as is compliance work for all significant desktop
       applications in use throughout the company.
 
       
        In addition to our internal remediation activities, we
       have completed an evaluation of readiness by our key suppliers
       and vendors, including those serving our wholly-owned foreign
       operations. Of 875 suppliers and vendors evaluated through
       personal interviews and site visits, fewer than 3% have been
       designated by us as deficient in their efforts. Action plans are
       being executed to address each of these deficient situations and
       at this time none is judged to be a significant risk to the
       continuity of operations. Nonetheless, we are conducting
       follow-up assessments of these and other critical suppliers and
       vendors. Separate Year 2000 compliance programs are in progress
       at Stream International and CS&T.
 
       
        Although the company expects internal systems to be Year
       2000 compliant as described above, we have developed contingency
       plans that specify what we plan to do if critical systems,
       processes, suppliers, vendors or external companies encounter
       Year 2000 issues. Our contingency planning effort
     focuses on those areas where our testing or evaluation does not
       demonstrate Year 2000 readiness, or where the criticality of the
       business process would make contingency planning prudent. While
       the specifics of each location’s plan varies, the general
       approach includes ensuring that key personnel, both local and at
       the Year 2000 program office, are on-site during the year-end
       cut-over; backing up critical systems immediately prior to
       year-end; and identifying alternate methods of doing business
       with suppliers and customers, if needed.
 
       
        Company employees, assisted by the expertise of external
       consultants where necessary, staff the Year 2000 compliance
       efforts. Actual spending on our Year 2000 initiative in 1998 was $45$2.4 million,
       of which is$1.1 million was reflected in administrative expense.
       Management expects 1999 expenses to be between $48expense and the
       remainder in cost of sales. We spent $15.5 million and
       $50 million, of which $41 million was incurredon Year 2000 costs in
       the first nine
       monthsquarter of 1999, of which $11.2 million was reflected in
       administrative expense and the year.remainder in cost of sales. These estimated
       expenses do not include costs being capitalized with respect to the company’sour
       information and technology infrastructure upgrade and standardization
       initiative or estimated costs associated withinitiatives. As internal resources complete their Year 2000 initiatives at Stream International or CS&T.
 
       
        Our failureassignments,
       they have been reallocated to be Year 2000 compliant, or the failure oftechnology projects that had been
       deferred, as well as to other productivity projects. These projects are
       expected to improve our key suppliers, vendors or customers to achieve compliance in
       a timely manner, could have a material adverse effect on the
       company. Despite our efforts, a short-term disruption in some of
       our operations could occur which our contingency planning
       attempts to, but may not fully, address. In particular, the
       company’s ability to operate in foreign markets could be
       materially affected by a failure ofshare information across the local infrastructure.
       company,
       make informed decisions rapidly, and enhance future
       productivity.

     
 

     
Other
       Information

     
 

     
         Share
       repurchaseRepurchase—In September, 1999, the board of directors
       authorized a share repurchase program to repurchasefor up to $300 million of the
       company’s common stock in privately negotiated or open-market
       transactions. The program includes shares purchased for issuance under
       various stock option plans. Pursuant toDuring the first quarter of 2000, we slowed
       our share repurchase program announced in September 1999,
       we repurchased 0.25 million shares under this program at an
       average priceactivity as a result of $28.83.increased acquisition
       activity.

     
 

     
         Since July 1996, under other share repurchase programs,During the first
       quarter of 2000, we have repurchasedpurchased approximately 28.10.9 million shares, or about 18%at an
       average price of our outstanding shares, at a total cost of approximately $1
       billion.$23.75. This program extends through September
       2000.

     
 

     
       
        Technology—We remain a technology leader, investing not only in
       print-related technologies such as computer-to-plate customer connectivity and digital
       imaging
       capabilities, but alsoprinting, in Internet-based business models such as Online Services, and
       in Internet-enabled services such as SENDD™ and ImageMerchant™
       (see below for a description of these services). We are focused on
       investing in technologies that contribute to our SelectSource®financial performance
       and HouseNet® services. These
       businesses help us deliver products, services and solutions that are valued by
       our customers effectively deliver their content
       on the Internet.customers.

     
 

     

               SelectSource During 1999, we received
       recognition for our technology leadership from both PC Week and
       HouseNet addressInformation Week. Among all U.S. companies, we were
       named:
 
·
#6 of the top
         100 in Enterprise Solutions (PC Week, September 13,
         1999)
 
·
#25 of the top
         100 in Internet Technology (PC Week, May 11, 1999)
 
·
#36 of the top
         100 in Desktop and Mobile Technology (PC Week, June 21,
         1999)
 
·
#66 of the top
         500 e-business leaders (PC Week, November 15, 1999)
 
·
#88 of the top
         500 leading IT innovators (Information Week, September 27,
         1999)
 
        Online
       Services, SENDD, ImageMerchant, Digital Print and
       E-Books—Online Services offers solutions to meet all of our
       customers’ Internet needs. Online Services provides a full suite of
       scalable e-commerce solutions including consulting, Web site design and
       development, content production services to “stock the
       online needsshelves” or populate the site with content, and marketing services
       to effectively drive site traffic. The markets that Online Services
       currently serves include:
 
·
eCommerce—to help catalogers and retailers showcase their
         products on the Internet and drive sales
 
·
ePublish—to help magazine publishers extend and enhance
         their brands online by offering content as well as commerce and
         community
 
·
eDirectory—to help businesses navigate and use the
         Internet to gain exposure and streamline their business
         processes.
 
        Our recent
       partnerships and investments in this arena strengthen our Online
       Services offering, expand our solutions and help our customers leverage
       the power of catalogers and publishers, respectively. SelectSource offers
       content conversion and site development services for catalog and
       retailthe Internet to communicate with their
       customers. HouseNet, an online community of interest
       focused on home improvement topics, aggregates content around
       the themes of home, garden, crafts and money management to offer
       a one-stop information resource for consumers. HouseNet was
       named Yahoo!’s number-one site for home improvement
       information for 1998.

     
 

     
        To meet our
       Financial Services customers’ needs for speed, convenience,
       confidentiality and accuracy, we developed SENDD. The software allows
       work groups around the world to simultaneously proof a document securely
       via the Internet. Financial Services is also working closely with the
       Securities and Exchange Commission (SEC) on the modernization efforts
       under way for EDGAR (Electronic Data Gathering and Retrieval). We
       currently provide EDGAR electronic filing services for our customers,
       enabling them to communicate with their target audiences while meeting
       tight time frames and stringent filing requirements. We will continue to
       develop our offerings and educate our clients as the SEC enhances EDGAR
       in the future.
 
        In our premedia
       production process, increased digitization allows us to capture customer
       content and distribute it via various communication media, including
       print and the Internet. We have developed technology that allows a
       customer to securely archive its digital content in an R.R. Donnelley
       database and access it via the Internet so that it can be repurposed for
       multiple uses. This ImageMerchant software allows customers to more
       effectively manage their media assets. Customer benefits include lower
       costs, faster production times and consistent quality because images are
       repurposed rather than recreated. Analysis tools further enhance the
       value of ImageMerchant.
 
        Additionally, we
       are a leading provider of digital print, which allows customized
       marketing to an audience of one. With digital printing, images can be
       varied as they are printed, allowing for each piece to be highly
       personalized.
 
        Book Publishing
       Services also applies technology to create solutions that enable our
       customers to manage and distribute content in multiple media formats. Our digital archiving and
       customer publishing solution allows education customers to build
       books online. In addition, Book Publishing Services is the
       leading supplier of conversion services to the emerging
       electronic book marketplace.
 
       
        In the production processWe
       currently convert content for print, increased
       digitization allows us to implement world-class manufacturing
       techniques. Digital workflows, coupled with on-press
       instrumentation and advanced statistical process control
       techniques, allow us to more effectively manage both our
       manufacturing assets and our raw material inputs. Additionally,
       new digital imaging capabilities are allowing higher levels of
       customization, enabling highly personalized printed products to
       be delivered to consumers.many major e-book vendors.

     
 

     

              
        We are focusedLitigation—In 1996, a purported class action was
       brought against us in federal district court in Chicago, Illinois, on
       investingbehalf of all current and former African-American employees, alleging
       that we racially discriminated against them in technologies that help us
       deliver products, servicesviolation of the Civil
       Rights Act of 1871, as amended, and solutions that are valued bythe U.S. Constitution (Jones, et
       al. v. R.R. Donnelley & Sons Co.). The complaint seeks
       declaratory and injunctive relief, and asks for actual, compensatory,
       consequential and punitive damages in an amount not less than $500
       million. Although plaintiffs seek nationwide class certification, most
       of the specific factual assertions of the complaint relate to the
       closing of our customers and thereby contributeChicago catalog operations in 1993. Other general claims
       relate to other company locations. In August 1999, the district court
       judge denied our financial performance.
       motion for partial summary judgment on the basis of
       timeliness.

     
 

     
         Litigation—See Note 4In 1995, a
       purported class action was filed against us in federal district court in
       Chicago alleging that older workers were discriminated against in
       selection for termination upon the closing of the NotesChicago catalog
       operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The
       suit also alleges that we violated the Employee Retirement Income
       Security Act (ERISA) in determining benefits payable to Condensed Consolidated Financial Statements includedretiring or
       terminated employees. In August 1997, the court certified classes in
       Part Iboth the age discrimination and ERISA claims limited to former employees
       of the Chicago catalog operations.
 
        In 1998, a
       purported class action was filed against us in federal district court in
       Chicago on behalf of current and former African-American employees,
       alleging that the company racially discriminated against them in
       violation of Title VII of the Civil Rights Act of 1964 (Adams, et al.
       v. R.R. Donnelley & Sons Co.). While making many of the same
       general discrimination claims contained in the 1996 case, the plaintiffs
       in this case also claim retaliation by the company for the filing of
       discrimination charges or otherwise complaining of race discrimination.
       The complaint seeks the same relief and damages as sought in the 1996
       case.
 
        The 1996
       and 1995 cases relate primarily to the circumstances surrounding the
       closing of the Chicago catalog operations. We believe we acted properly
       in the closing of the operations. We also believe we have a number of
       valid defenses to all of the claims made and will vigorously defend our
       actions. However, because the cases are in the preliminary stages, we
       cannot make a meaningful estimate of any loss that could result from an
       unfavorable outcome of any of the pending cases.
 
        In December 1999,
       the U.S. Environmental Protection Agency, Region 5 (U.S. EPA) issued a
       Notice of Violation against us, pursuant to section 113 of the Clean Air
       Act (the Act). The notice alleges that our facility in Willard, Ohio,
       violated the Act and Ohio’s State Implementation Plan in installing
       and operating certain equipment without appropriate air permits. While
       the notice does not specify the remedy sought, upon final determination
       of a violation, U.S. EPA may issue an administrative order requiring the
       installation of air pollution control equipment, assess penalties, or
       commence civil or criminal action against us. We responded to U.S. EPA
       on March 10, 2000. We do not believe that any unfavorable result of this
       Form 10-Q.proceeding will have a material impact on our financial position or
       results of operations.
 
        In addition, we
       are a party to certain litigation arising in the ordinary course of
       business which, in the opinion of management, will not have a material
       adverse effect on the operations or financial condition of the
       company.

     
 

     
        Environmental
       Regulations—Our business is subject to various laws and
       regulations relating to employee health and safety and to environmental
       protection. Our policy is to comply with all laws and regulations that
       govern protection of the environment and employee health and safety. We
       do not anticipate that compliance will have a material adverse effect on
       our competitive or consolidated financial positions.

     
 

     
       
        Outlook—TheOur primary business remains commercial
       printing industry inand our primary geographic market is the United States (our primary geographic market) isStates. The
       environment remains highly competitive in most of our product categories
     and geographic regions. Competition is based largely based on price, quality and
       servicing the special needs of customers. Industry analysts believe that
       there is overcapacity in most commercial printing markets. Therefore,
       competition is fierce.intense. Our intent is to differentiate our service
       offering so that we are viewed by our customers as a partner who can
       help them more effectively use words and images in a variety of ways,
       whether through print or the Internet, to reach their target
       audiences.

     
 

     
        We are a large
       user of paper, bought by us or supplied to us by our customers. The cost
       and supply of certain paper grades used in the manufacturing process
       will continue to affect our financial results, primarily at the revenue line.results. However, management
       currently does not see any disruptive conditions affecting prices and
       supply of paper in 1999.2000.

     
 

     
         Postal costs are
       a significant component of our customers’ cost structures. However, changesChanges
       in postal rates, which became effectiveare anticipated early in January 1999, did not2001, may negatively
       affect the company. In fact,demand for our core print capabilities, but postal rate
       increases enhance the value of DLSLogistics Services to our customers, as
       we are able to improve the cost and
       efficiency of mail processing and
       distribution. This ability to
       deliver mail on a more precise schedule and at a lower cost
       enhances our position in the marketplace.

     
 

     
        In addition to
       paper and postage costs, consumer confidence and economic growth are key
       drivers of print demand. While current economic conditions remain favorable, there is
       uncertainty around the future business environment. A significant change in the economic outlook
       could affect demand for the company’sour products, particularly in the financial
       printing market.

     
 

     
        In the longer
       term, technological changes, including the electronic distribution of
       information, present both risks and opportunities for the company. Many
       of our new business initiatives are designed to leverage our distinctive
       capabilities to participate in the rapid growth in electronic
       communications. Our goal remains to manage and distribute words and
       images, regardless of the means of distribution, to help our customers
       succeed in informing, educating, entertaining and selling. 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 sustained growth inincreased
       shareholder value.

     
 

     
Item
       3

     
 

     
Quantitative
       and Qualitative Disclosures About Market Risk

     
 

     
        We are exposed to
       market risk from changes in interest rates and foreign exchange rates.
       However, we generally maintain more than half of our debt at fixed rates
       (approximately 67%51% at September 30, 1999)March 31, 2000), and therefore our exposure to short-term
       interest rate fluctuations is immaterialnot material to the consolidated financial
       statements as a whole. Our exposure to adverse changes in foreign
       exchange rates also is immaterial to our consolidated financial
       statements as a whole, and we occasionally use financial instruments to
       hedge exposures to foreign exchange rate changes. We do not use
       financial instruments for trading purposes and are not a party to any
       leveraged derivatives. Further disclosure relating to financial
       instruments is included in the Debt Financing and Interest Expense note
       in the Notes to Consolidated Financial Statements included in our 19981999
       Annual Report on Form 10-K.

     
 

     
 PART
       II

     
 

     
OTHER
       INFORMATION

     
 

     
Item 1. Legal
       Proceedings

     
 

     
        On each of
       November 25, 1996, and June 30, 1998, purported class actions were
       brought against the company alleging racial discrimination and seeking
       actual, compensatory, consequential and punitive damages in an amount
       not less than $500 million. On December 18, 1995, a class action was
       brought against the company alleging age discrimination in connection
       with the 1993 closing of the company’s Chicago catalog operations,
       and violation of the Employee Retirement Income Security Act. These
       actions are described in Partpart 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 23, 2000.
 
(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 2003, was
         voted on by the stockholders. The nominees, all of whom were elected,
         were James R. Donnelley, Thomas S. Johnson and George A. Lorch. The
         Inspectors of Election certified the following vote
         tabulations:
 
     For
    Withheld
James R.
         Donnelley    104,230,650    815,312
Thomas S.
         Johnson    104,208,723    837,239
George A.
         Lorch    104,191,250    854,712
 
        2. A proposal
         to adopt a new stock incentive plan was approved by the stockholders.
         The Inspectors of Election certified the following vote
         tabulations:
 
For
  %
  Against
  %
  Abstain
  %
  Non-Vote
  %
66,585,386  63%  31,614,656  30%  831,187  1%  6,014,733  6%
 
         
                3. A stockholder proposal
         regarding pay equity was rejected by the stockholders. The Inspectors
         of Election certified the following vote tabulations: 
For
  %
  Against
  %
  Abstain
  %
  Non-Vote
  %
6,234,321  6%  89,524,283  85%  3,272,625  3%  6,014,733  6%
 
         
                 4. A stockholder proposal
          regarding global corporate standards was rejected by the
          stockholders. The Inspectors of Election certified the following vote
          tabulations: 
For
  %
  Against
  %
  Abstain
  %
  Non-Vote
  %
4,088,254  4%  89,199,355  85%  5,743,620  5%  6,014,733  6%
 
Item 5.
         Other Information

       
 

       
         Certain
         statements in this filing, including the discussions of management
         expectations for future periods and
       Year 2000, compliance, 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 19981999 Annual Report on Form 10-K for a description
         of such factors.-factors.

       
 

       
Item 6.
         Exhibits and Reports on Form 8-K.

       
 

       
         (a)
         Exhibits


       

        

         10    Consulting
           Agreement between Cheryl A. Francis and R.R. Donnelley & Sons
         

         Company
 
 
12
             
         ComputationRatio of
           Earnings to Fixed Charges
        

        

          
 
27
             
         Financial
           Data Schedule
        

       

       
 

       
         (b) No current
         report on Form 8-K was filed during the thirdfirst quarter of
         1999.2000.

       
 

       

         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
         /    GREGORY 
         A. STOKLOSA
         

         		
        

       


       

        

         
          
By 

         		
        

       


       

        

         
          

         Corporate ControllerActing Chief
           Financial Officer

         		
        

       


       

        

         
          

         (Authorized(Authorized
           Officer and

         		
        

       


       

        

         
          
Chief
           Accounting Officer)

         		
        

       

       
 


       

        

         
          

         NovemberMay 12,
           19992000

         		
        

       

       
Date