- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 JUNE 30, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-4694
R. R. DONNELLEY & SONS COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 36-1004130
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
77 WEST WACKER DRIVE, CHICAGO,
ILLINOIS 60601
(ADDRESS OF PRINCIPAL EXECUTIVE (ZIP CODE)
OFFICES)
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.
X
Yes------- No -------
NUMBER OF SHARES OF COMMON STOCK
OUTSTANDING
AS OF JULY 31, 1997 146,296,724
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAGE
INDEX NUMBER(S)
----- ---------
Condensed Consolidated Statements of Income (Unaudited) for
the three and six month periods ended June 30, 1997 and
1996........................................................ 3
Condensed Consolidated Balance Sheets as of June 30, 1997
(Unaudited) and December 31, 1996........................... 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the six months ended June 30, 1997 and 1996............. 5
Notes to Condensed Consolidated Financial Statements
(Unaudited)................................................. 6-7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Comparison of Second Quarter and First Half 1997 to 1996..... 8-12
Changes in Financial Condition............................... 12
Other Information............................................ 12-13
Outlook...................................................... 14
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.................................... 15
Item 6. Exhibits and Reports on Form 8-K..................... 15
2
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
----------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
-------------------------- --------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Net sales............... $ 1,504,997 $ 1,569,114 $ 2,980,235 $ 3,104,526
Cost of sales........... 1,255,522 1,279,052 2,496,975 2,573,641
------------ ------------ ------------ ------------
Gross profit............ 249,475 290,062 483,260 530,885
Selling and
administrative
expenses............... 181,079 184,792 353,725 363,273
Restructuring charges... -- 48,084 -- 560,632
------------ ------------ ------------ ------------
Earnings (loss) from
operations............. 68,396 57,186 129,535 (393,020)
Other income (expense):
Interest expense...... (22,622) (24,713) (45,182) (49,796)
Gain on Metromail
stock offering....... -- 44,158 -- 44,158
Other income
(expense)--net....... 12,638 2,982 19,548 29,558
------------ ------------ ------------ ------------
Earnings (loss) before
income taxes........... 58,412 79,613 103,901 (369,100)
Provision (benefit) for
income taxes........... 20,736 25,336 36,885 (46,458)
------------ ------------ ------------ ------------
Net income (loss)....... $ 37,676 $ 54,277 $ 67,016 $ (322,642)
============ ============ ============ ============
Per common share:
Net income (loss)..... $ 0.26 $ 0.35 $ 0.46 $ (2.09)
============ ============ ============ ============
Cash dividends........ $ 0.19 $ 0.18 $ 0.38 $ 0.36
============ ============ ============ ============
Average shares
outstanding............ 146,431,909 154,113,294 146,076,430 154,062,081
============ ============ ============ ============
See accompanying Notes to Condensed Consolidated Financial Statements.
3
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
------------
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 1997 AND DECEMBER 31, 1996
(THOUSANDS OF DOLLARS)
ASSETS
1997 1996
---------- ----------
Cash and equivalents............................. $ 70,669 $ 31,142
Receivables, less allowance for doubtful accounts
of $44,849 and $24,735 at June 30, 1997 and
December 31, 1996, respectively................. 1,058,241 1,324,252
Inventories...................................... 257,983 288,506
Prepaid expenses................................. 145,745 108,957
---------- ----------
Total current assets........................... 1,532,638 1,752,857
---------- ----------
Property, plant and equipment, at cost........... 4,424,978 4,289,101
Less accumulated depreciation.................... 2,430,604 2,344,374
---------- ----------
Net property, plant and equipment.............. 1,994,374 1,944,727
---------- ----------
Goodwill and other intangibles--net.............. 513,232 541,319
Other noncurrent assets.......................... 633,748 610,101
---------- ----------
Total assets................................... $4,673,992 $4,849,004
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable................................. $ 388,001 $ 487,914
Accrued compensation............................. 159,971 131,644
Short-term debt.................................. 33,296 33,296
Current and deferred income taxes................ 56,977 56,163
Other accrued liabilities........................ 407,303 438,530
---------- ----------
Total current liabilities...................... 1,045,548 1,147,547
---------- ----------
Long-term debt................................... 1,334,682 1,430,671
Deferred income taxes............................ 251,981 253,850
Other noncurrent liabilities..................... 391,720 385,655
Shareholders' equity:
Common stock, at stated value ($1.25 par
value)........................................ 320,962 320,962
Retained earnings, net of cumulative
translation adjustments of $29,219 and $26,580
at June 30, 1997 and December 31, 1996,
respectively.................................. 1,489,146 1,486,215
Unearned compensation.......................... (12,419) (5,402)
Reacquired common stock, at cost............... (147,628) (170,494)
---------- ----------
Total shareholders' equity................. 1,650,061 1,631,281
---------- ----------
Total liabilities and shareholders' equity. $4,673,992 $4,849,004
========== ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
4
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30
(THOUSANDS OF DOLLARS)
1997 1996
--------- ---------
Cash flows provided by (used for) operating activities:
Net income (loss)...................................... $ 67,016 $(322,642)
Restructuring charges, net of tax and minority
interest.............................................. -- 435,380
Depreciation........................................... 171,844 176,608
Amortization........................................... 19,739 33,155
Gain on Metromail stock offering....................... -- (44,158)
Gain on sale of assets................................. (11,770) (16,310)
Net change in operating working capital................ 160,460 144,746
Net change in other assets and liabilities............. 11,778 (21,979)
Other.................................................. (3,254) (7,786)
--------- ---------
Net cash provided by operating activities................ 415,813 377,014
--------- ---------
Cash flows provided by (used for) investing activities:
Capital expenditures................................... (242,691) (235,997)
Proceeds from receivables from Metromail............... -- 248,510
Other investments including acquisitions, net of cash
acquired.............................................. (37,333) (22,368)
Dispositions of assets................................. 45,381 18,068
--------- ---------
Net cash provided by (used for) investing activities..... (234,643) 8,213
--------- ---------
Cash flows provided by (used for) financing activities:
Net increase (decrease) in borrowings.................. (95,989) (332,616)
Disposition of reacquired common stock................. 25,086 25,849
Acquisition of common stock............................ (14,081) (25,831)
Cash dividends on common stock......................... (56,603) (55,514)
--------- ---------
Net cash used for financing activities................... (141,587) (388,112)
--------- ---------
Effect of exchange rate changes on cash and equivalents.. (55) 455
--------- ---------
Net increase (decrease) in cash and equivalents.......... 39,528 (2,429)
--------- ---------
Cash and equivalents at beginning of period.............. 31,142 33,122
--------- ---------
Cash and equivalents at end of period.................... $ 70,670 $ 30,693
========= =========
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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, 1996 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 1996 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 immaterial prior year amounts have been reclassified
to maintain comparability with current year classifications.
Note 2. Components of the company's inventories at June 30, 1997 and December
31, 1996 were as follows:
(THOUSANDS OF
DOLLARS)
------------------
1997 1996
-------- --------
Raw materials and manufacturing supplies.................... $127,016 $154,734
Work in process............................................. 180,317 183,248
Finished goods.............................................. 36,656 34,325
Progress billings........................................... (41,680) (40,475)
LIFO reserve................................................ (44,326) (43,326)
-------- --------
Total inventories....................................... $257,983 $288,506
======== ========
Note 3. The following provides supplemental cash flow information:
(THOUSANDS OF
DOLLARS)
---------------
SIX MONTHS
ENDED
JUNE 30
---------------
1997 1996
------- -------
Cash flow data:
Interest paid, net of capitalized interest.................... $44,546 $50,561
Income taxes paid............................................. $31,168 $31,847
6
Note 4. In the first half of 1996, the company provided for the
restructuring and realignment of its gravure printing operations in North
America, the repositioning of other businesses, the write-down of certain
equipment, and the impairment of intangible assets and investments in non-core
businesses. These actions resulted in pre-tax charges of $561 million ($435
million after taxes and a minority interest benefit). Approximately $195
million of the charges related to its gravure platform realignment and
approximately $233 million related to other manufacturing restructuring. Pre-
tax cash outlays associated with the restructuring and realignment charges are
expected to total approximately $177 million, of which $69 million was
incurred through June 1997, with the remainder expected to be incurred through
the first half of 1998. In addition, the company recognized the impairment of
approximately $133 million in equipment, intangibles and investments in non-
core businesses. The impairment loss was calculated based on the excess of the
carrying amount of the assets over the assets' fair values. The fair value of
an asset is generally determined as the discounted estimates of future cash
flows generated by the asset.
The following table presents the components of the company's restructuring
reserves along with charges against these reserves from their establishment
until June 30, 1997 (in thousands of dollars):
WRITEDOWN OF
PROPERTY AND
ORIGINAL INVESTMENTS RESTRUCTURING
RESTRUCTURING TO FAIR CASH RESERVES AS OF
CHARGES VALUE PAYMENTS JUNE 30, 1997
------------- ------------ -------- --------------
Restructuring loss on
writedown of property,
plant and equipment, and
other assets.............. $250,731 $(250,731) $ -- $ --
Restructuring expenditures
to reposition operations
and close facilities...... 176,960 -- (68,952) 108,008
Impairment loss on
intangible assets and
investments............... 132,941 (132,941) -- --
-------- --------- -------- --------
Total restructuring
reserves.............. $560,632 $(383,672) $(68,952) $108,008
======== ========= ======== ========
Note 5. On November 25, 1996, a purported class action was brought against
the company in federal district court in Chicago, Ill., on behalf of all
current and former African-American employees, alleging that the company
racially discriminated against them. The complaint seeks declaratory and
injunctive relief, and asks for actual, compensatory, consequential and
punitive damages in an amount not less than $500 million. Most of the specific
factual assertions of the original complaint were related to the closing by
the company of its Chicago, Ill., catalog production operations begun in 1993.
The complaint was amended on February 7, 1997, to reflect more general claims
applicable to other company locations. Plaintiffs have filed a motion seeking
nationwide class certification. The company has filed a motion for partial
summary judgment as to all claims relating to its Chicago catalog operations
on the grounds that those claims are untimely.
On December 18, 1995, a purported class action was filed against the company
in federal district court in Chicago, Ill., alleging that older workers were
discriminated against in selection for termination upon the closing of the
Chicago catalog operations. 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 October 8, 1996, plaintiffs
filed a motion to maintain the ERISA claims as a class action on behalf of all
company retirement plan participants who were eligible for early retirement
benefits at the time of their termination. The company's position is that the
proper ERISA class is limited to the former Chicago employees.
Both cases relate at least in part to the circumstances surrounding the
closure of the Chicago catalog operations. The company believes that it acted
properly in the closing of the operations, has a number of valid defenses to
all of the claims made and is vigorously defending its actions. However,
management is unable to make a meaningful estimate of any loss which could
result from an unfavorable outcome of either case.
7
MANAGEMENT DISCUSSION AND ANALYSIS
COMPARISON OF SECOND QUARTER AND FIRST HALF 1997 TO 1996
ABOUT THE COMPANY
R. R. Donnelley & Sons Company is a world leader in distributing, managing
and reproducing print and digital information for the publishing, retailing,
merchandising and information-technology markets worldwide. The company is the
largest commercial printer in North America, with approximately 38,000
employees in 26 countries on five continents.
The company is organized into sectors, which include the following business
units and subsidiaries:
Commercial Print Sector, which includes Merchandise Media (catalogs,
retail advertising circulars and direct mail products) and Magazine
Publishing Services (consumer and trade magazines). These businesses share
common requirements in scale, equipment, services and distribution.
Information Management Sector, which includes Book Publishing Services,
Telecommunications (domestic directories) and Financial Services (financial
printing and communications process services). These businesses serve
customers that need to reproduce and distribute information in a variety of
formats globally and share requirements for speed, flexibility and
integrated manufacturing.
This sector also includes Information Services, which includes the 77
Capital venture-capital fund, creative design and communication services,
and a variety of information services. These operations provide direct
marketing, graphics-management and graphic-design services.
Global Commercial Print Sector, which includes the company's directory,
book, magazine and catalog operations outside North America--in Europe,
Latin America and Asia.
Stream International Holdings, Inc. (SIH), which includes Modus Media
International (software replication, documentation and kitting and
assembly), Corporate Software & Technology (licensing and fulfillment,
customized documentation, license administration and user training) and
Stream International (technical and help-line support). The business was
formed in April 1995 by a merger of the company's Global Software Services
business with Corporate Software Inc. Approximately 80% owned by the
company, it is the world's largest software manufacturer, marketer and
technical support and service provider.
On April 30, 1997, SIH announced that a registration statement had been
filed with the Securities and Exchange Commission for the proposed initial
public offering of the common shares of Stream International. Immediately
prior to the closing of the proposed offering, SIH would be reorganized
such that the only business it conducts would be the outsource technical
support business, which has changed its name to Stream International Inc.
SIH's two other business units, Corporate Software & Technology and Modus
Media International, would be spun off as two subsidiaries of a separate
entity, the equity of which would be distributed to the current SIH
stockholders. After completion of the reorganization and public offering,
the company would own less than 40% of the outstanding shares of Stream
International and less than a majority interest in the remaining two
business units, and would thereafter account for these interests using the
equity method. Proceeds to the company from the completed offering would be
used to pay down debt and for general corporate purposes. The planned
offering of Stream International shares will be made only by means of a
prospectus.
8
Sales results by business unit for the second quarter and first half of 1997
and 1996 are presented below:
NET SALES BY BUSINESS UNIT--SECOND QUARTER
SECOND QUARTER ENDED JUNE 30, % OF % OF
(THOUSANDS OF DOLLARS) 1997 SALES 1996 SALES
- ----------------------------- ------- ----- ------- -----
Stream International Holdings, Inc. ................ 414,879 28% 404,115 26%
Merchandise Media................................... 275,598 18% 288,056 18%
Magazine Publishing Services........................ 263,050 17% 251,778 16%
Book Publishing Services............................ 182,116 12% 161,369 10%
Telecommunications.................................. 132,655 9% 164,602 11%
Financial Services.................................. 132,308 9% 114,279 7%
Global Commercial Print............................. 84,557 6% 74,600 5%
Metromail........................................... -- -- 69,383 4%
Other............................................... 19,834 1% 40,932 3%
NET SALES BY BUSINESS UNIT--YEAR TO DATE
FIRST HALF ENDED JUNE 30, % OF % OF
(THOUSANDS OF DOLLARS) 1997 SALES 1996 SALES
- ------------------------- ------- ----- ------- -----
Stream International Holdings, Inc.................. 836,823 28% 795,633 26%
Merchandise Media................................... 553,727 19% 579,495 19%
Magazine Publishing Services........................ 530,605 18% 529,747 17%
Book Publishing Services............................ 353,165 12% 317,509 10%
Telecommunications.................................. 268,894 9% 313,216 10%
Financial Services.................................. 247,587 8% 202,393 6%
Global Commercial Print............................. 155,596 5% 157,107 5%
Metromail........................................... -- -- 125,522 4%
Other............................................... 33,838 1% 83,904 3%
CONSOLIDATED RESULTS OF OPERATIONS
The company reported second quarter 1997 net income of $38 million, or $0.26
per share. In the previous year's second quarter, the company reported net
income of $54 million, or $0.35 per share, reflecting a $48 million pre-tax
restructuring charge recorded in the period ($24 million after taxes and a
minority interest benefit) that was primarily related to the repositioning of
Modus Media International, as well as a $44 million pre-tax gain ($26 million
after taxes) related to the June 1996 initial public offering of shares of
Metromail Corporation (Metromail). Excluding the restructuring charge and the
Metromail gain, net income for the second quarter of 1996 totaled $52 million,
or $0.34 per share. Second quarter 1997 net income declined 28%, and earnings
per share declined 24%, from the comparable quarter in 1996, excluding the
restructuring charge and the Metromail gain.
For the first half of 1997, the company reported net income of $67 million,
or $0.46 per share. In the previous year's first half, the company reported a
net loss of $323 million, or $2.09 per share, reflecting the $512 million pre-
tax restructuring charge ($411 million after taxes and a minority interest
benefit) recorded in the first quarter of 1996, as well as the above-mentioned
restructuring charge and Metromail gain recorded in the second quarter of
1996. Excluding the restructuring charges and the Metromail gain, net income
for the first half of 1996 totaled $86 million, or $0.56 per share. First half
net income declined 22%, and earnings per share declined 18%, from last year's
first half, excluding the restructuring charges and the Metromail gain.
The company's performance in the second quarter of 1997 was impacted by
declines in the Telecommunications business unit due to volume and price
reductions corresponding to contract renewals, increased losses in SIH due to
declines in demand at Modus Media International and
9
increased costs of operating SIH as three separate businesses. In addition,
performance in the second quarter and first half of 1997 was impacted by higher
expenses associated with the continued development of the company's logistics
and fulfillment businesses and the startup of a short-run, four-color book
printing facility in Roanoke, Virginia (Roanoke facility).
CONSOLIDATED NET SALES
Net sales for the second quarter of 1997 decreased approximately $64 million,
or 4%, to approximately $1.5 billion. The decline was primarily due to price
and volume declines in Telecommunications (down approximately $32 million) and
the company's deconsolidation of Metromail due to reduced ownership following
the second quarter 1996 public offering (down $69 million). These declines were
partially offset by increased revenues in most business units, particularly in
Book Publishing Services and Financial Services.
Net sales from foreign operations represented approximately $254 million, or
17% of total net sales, in the second quarter, down 6% from $269 million, or
17% of total net sales, in the year earlier quarter. The decline in foreign
sales principally reflects the discontinuation of magazine and catalog printing
in the United Kingdom and the worldwide repositioning of Modus Media
International's foreign manufacturing operations, partially offset by increased
volume in Global Commercial Print.
Net sales for the first half decreased $124 million, or 4%, to approximately
$3.0 billion. The decline was primarily due to: lower paper prices in the first
quarter compared with the first quarter of 1996 (down approximately $50
million); price and volume declines in Telecommunications (down approximately
$44 million); and the company's deconsolidation of Metromail (down $126
million). These declines were partially offset by increased revenues primarily
in SIH, Financial Services and Book Publishing Services.
Net sales from foreign operations represented approximately $503 million, or
17% of total net sales, in the first half, down 4% from $525 million, or 17% of
total net sales, in the first half of 1996. The decline in foreign sales for
the first half reflects the factors identified above for the second quarter.
CONSOLIDATED EXPENSES
Gross profit declined 14% to $249 million and 9% to $483 million in the
second quarter and first half of 1997, respectively, from the comparable 1996
periods. The declines reflect the company's reduced ownership of Metromail
(down $32 million for the second quarter and $51 million for the first half),
price and volume declines in Telecommunications, and higher expenses associated
with the continued development of the company's logistics and fulfillment
businesses and the startup of the Roanoke facility. In addition, the indirect
costs of restructuring activities led to temporarily higher manufacturing costs
in the company's gravure platform and in the United Kingdom during the periods.
These declines were partially offset by manufacturing cost improvements in most
business units.
Selling and administrative expenses in the second quarter of 1997 declined 2%
to $181 million, due to the company's reduced ownership of Metromail (down $21
million), partially offset by volume-related increases primarily in the
Financial Services and Book Publishing Services business units. The ratio of
selling and administrative expense to net sales, at 12%, was the same in both
the second quarters of 1997 and 1996. Interest expense decreased approximately
$2 million, due to lower average debt balances associated with improvements in
operating working capital and the reduction of debt using a portion of the
proceeds of the fourth quarter 1996 public offering of Donnelley Enterprise
Solutions Incorporated (DESI). Other income in the second quarter 1997
decreased $35 million, primarily due to non-recurring events in the second
quarter of 1996, including a $44 million gain on the June 1996 Metromail public
offering and a $4 million minority interest benefit arising from SIH's portion
of the second quarter restructuring charge. These non-recurring events were
partially offset by 1997 gains on the sale of investments in the company's
venture-capital portfolio.
10
Selling and administrative expenses in the first half of 1997 declined 3% to
$354 million, due to the company's reduced ownership of Metromail (down $39
million), partially offset by volume-related increases primarily in the
Financial Services and Book Publishing Services business units. The ratio of
selling and administrative expenses to net sales, at 12%, was the same in both
the first half of 1997 and 1996. Interest expense decreased approximately $5
million, due to lower average debt balances associated with improvements in
operating working capital and the reduction of debt using a portion of the
proceeds of the public offering of DESI. Other income for the half decreased
$54 million, primarily due to non-recurring events in the first half of 1996,
including a $14 million gain on the sale of investments in the company's
venture-capital portfolio, a $44 million gain on the June 1996 Metromail
public offering and a $17 million minority interest benefit arising from SIH's
portion of the restructuring charges. These non-recurring events were
partially offset by a $6 million gain on the sale of the company's interest in
a magazine distribution venture in the United Kingdom and gains on the sale of
investments in the company's venture-capital portfolio.
SUMMARY OF EXPENSE TRENDS
SECOND QUARTER ENDED JUNE 30, % INCREASE
(THOUSANDS OF DOLLARS) 1997 1996 (DECREASE)
- ----------------------------- ---------- ---------- ----------
Cost of materials.............................. $707,045 $729,429 (3)%
Cost of manufacturing.......................... 446,590 448,937 (1)%
Depreciation................................... 90,227 85,052 6%
Amortization................................... 11,660 15,634 (25)%
Selling and administrative..................... 181,079 184,792 (2)%
Net interest expense........................... 22,622 24,713 (8)%
FIRST HALF ENDED JUNE 30, % INCREASE
(THOUSANDS OF DOLLARS) 1997 1996 (DECREASE)
- ------------------------- ---------- ---------- ----------
Cost of materials.............................. $1,400,475 $1,461,235 (4)%
Cost of manufacturing.......................... 904,917 902,643 3%
Depreciation................................... 171,844 176,608 (3)%
Amortization................................... 19,739 33,155 (40)%
Selling and administrative..................... 353,725 363,273 (3)%
Net interest expense........................... 45,182 49,796 (9)%
RESULTS OF OPERATIONS OF PRINT-RELATED BUSINESSES AND OF SIH
Print-Related Businesses
Net sales for the company's print-related businesses (all consolidated
business units other than SIH and excluding Metromail in 1996) in the second
quarter of 1997 remained consistent with second quarter 1996 at $1.1 billion.
Increased demand primarily in the Book Publishing Services and Financial
Services business units was offset by price and volume declines in
Telecommunications. Print-related businesses had operating income of $78
million, a 19% decline from the same quarter in 1996, excluding the
restructuring charge. The decrease was attributable to higher expenses
associated with the continued development of the company's logistics and
fulfillment businesses, the startup of the Roanoke facility, and price and
volume declines in Telecommunications.
For the first half of 1997, net sales declined $40 million to $2.1 billion,
primarily reflecting lower paper prices, in addition to the factors identified
above. Operating income was $148 million, an 11% decline from the first half
of 1996, excluding the 1996 restructuring charges. The decrease is
attributable to the factors identified above.
11
Stream International Holdings, Inc.
Net sales for SIH in the second quarter of 1997 increased by $11 million, or
3%, to $415 million. SIH had an operating loss of approximately $10 million, an
$8 million decline from the second quarter of 1996. The higher operating losses
reflect declines in demand in Modus Media International, and the increased
costs of operating SIH as three separate businesses.
For the first half of 1997, net sales for SIH increased by $41 million, or
5%, to $837 million. For the first half SIH had an operating loss of $18
million, an $8 million decline from the first half of 1996. The higher
operating loss is attributable to the factors identified above for the second
quarter and an additional bad debt reserve recorded in the first quarter of
1997.
CHANGES IN FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
For the first half of 1997, net cash flow provided by operating activities
increased by $39 million, or 10%, to $416 million. The increase is primarily
related to improvements in operating working capital.
Operating working capital (defined as inventories, accounts receivable and
prepaid expenses, minus accounts payable, accrued compensation and other
accrued liabilities, including the restructuring reserve) decreased $160
million in the first half of 1997. The decrease is due primarily to lower
inventory and accounts receivable, compared with a $145 million decrease during
the first half of 1996. Management believes that the company's cash flow and
borrowing capacity are sufficient to fund current operations and growth.
Capital expenditures in the first half totaled $243 million, including
purchases for the Roanoke facility and purchases related to revamping the
company's gravure manufacturing platform. Full-year capital spending is
expected to be between $450 million and $500 million.
At June 30, 1997, the company had an unused revolving credit facility of $550
million with a number of banks. This credit facility provides support for the
issuance of commercial paper and other credit needs. In addition, certain
subsidiaries of the company had credit facilities with unused borrowing
capacities totaling approximately $100 million at June 30, 1997.
OTHER INFORMATION
Metromail--On June 19, 1996, Metromail completed an initial public offering
of its common stock, resulting in the company's interest in Metromail being
reduced to approximately 38% and the company changing its method of accounting
for Metromail from consolidation to the equity method. Under the equity method,
the company recognizes in income its proportionate share of net income of
Metromail. Metromail had net sales and operating earnings of $69 million and
$11 million, respectively, in the second quarter of 1996 and $126 million and
$12 million, respectively, in the first half of 1996.
DESI--On November 4, 1996, DESI completed an initial public offering of its
common stock, resulting in the company's interest in DESI being reduced to
approximately 43% and the company changing its method of accounting for DESI
from consolidation to the equity method. Under the equity method, the company
recognizes in income its proportionate share of net income of DESI. DESI's net
sales and operating earnings were not material to the consolidated results of
the company in 1996.
Restructurings--On March 28, 1996, the company announced a $512 million pre-
tax charge to first quarter earnings ($411 million after taxes and a minority
interest benefit) to restructure and realign its gravure operations in North
America, reposition other businesses, and write down certain equipment,
investments in non-core businesses and intangible assets. Approximately $195
million of the charge was related to the gravure platform realignment.
Approximately $189 million was related to other manufacturing restructuring,
including approximately $92 million to reposition SIH's worldwide operations.
Additionally, the company wrote down approximately $128 million in equipment,
intangibles and investments in non-core businesses, in accordance with SFAS
121.
12
On July 25, 1996, the company announced a $48 million pre-tax restructuring
charge ($24 million after taxes and a minority interest benefit) primarily to
restructure SIH's software manufacturing, printing, kitting and fulfillment
operations. The restructuring reflects changes in customer demand, which is
shifting from disk-based media and printed materials to CD-ROM and other forms
of electronic media, packaging and delivery.
Pre-tax cash outlays associated with the restructuring and realignment
charges are expected to total approximately $177 million and will be incurred
through the first half of 1998 ($69 million of this amount has been paid
through June 30, 1997). The remaining $383 million relates to non-cash items,
mainly the write-down of fixed assets and goodwill.
Human Resources and Plant Closings--As part of the first-half 1996
restructuring discussed above, the company has discontinued catalog and
magazine printing operations in the United Kingdom, closed SIH's
Crawfordsville, Ind., documentation printing and diskette replication
operations, consolidated a stand-alone book bindery in Scranton, Pa., closed a
book prepress operation in Barbados and closed a gravure-printing plant in Casa
Grande, Ariz. In addition, as part of the first-half 1996 restructuring, the
company announced plans to close a gravure-printing plant in Newton, N.C.,
which is expected to occur by the end of 1997.
Subsequent to the second quarter, on July 7th, 1997, the company announced
plans to close a fulfillment and distribution center in Crawfordsville, Ind. In
addition, on July 23, 1997, the company announced plans to close CORIS, a
content management software subsidiary in Willowbrook, Ill. Both closings are
expected to occur by the end of 1997. Costs associated with the closings are
not expected to have a material effect on the financial statements.
Litigation--On November 25, 1996, a purported class action was brought
against the company in federal district court in Chicago, Ill., on behalf of
all current and former African-American employees, alleging that the company
racially discriminated against them. The complaint seeks declaratory and
injunctive relief, and asks for actual, compensatory, consequential and
punitive damages in an amount not less than $500 million. Most of the specific
factual assertions of the original complaint were related to the closing by the
company of its Chicago, Ill., catalog production operations begun in 1993. The
complaint was amended on February 7, 1997, to reflect more general claims
applicable to other company locations. Plaintiffs have filed a motion seeking
nationwide class certification. The company has filed a motion for partial
summary judgment as to all claims relating to its Chicago catalog operations on
the grounds that those claims are untimely.
On December 18, 1995, a purported class action was filed against the company
in federal district court in Chicago, Ill., alleging that older workers were
discriminated against in selection for termination upon the closing of the
Chicago catalog operations. 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 October 8, 1996, plaintiffs filed a
motion to maintain the ERISA claims as a class action on behalf of all company
retirement plan participants who were eligible for early retirement benefits at
the time of the termination. The company's position is that the proper ERISA
class is limited to the former Chicago employees.
Both cases relate at least in part to the circumstances surrounding the
closure of the Chicago catalog operations. The company believes that it acted
properly in the closing of the operations, has a number of valid defenses to
all of the claims made and is vigorously defending its actions. However,
management is unable to make a meaningful estimate of any loss which could
result from an unfavorable outcome of either case.
Corporate-Owned Life Insurance--As a part of the Health Insurance Portability
and Accountability Act enacted in August 1996, the income tax deduction for
interest on loans from corporate-owned life insurance (COLI) policies is being
phased out and then eliminated, effective in
13
1999. The company has used loans from COLI to finance certain employee
benefits liabilities, and the loss of the interest deduction may cause the
company's effective tax rate to rise as the deduction is phased out over the
next few years.
Share Repurchase--The company announced and completed the repurchase of $250
million of its common stock in 1996, which was in addition to its ordinary
purchase of 1.8 million shares for issuance under various employee stock
plans. The number of shares outstanding at June 30 1997, was 146 million, with
an average outstanding number of shares for the half of 146 million. In the
first half of 1996, the average outstanding number of shares was 154 million.
OUTLOOK
The commercial printing business in North America (the company's primary
geographic market) is highly competitive in most product categories and
geographic regions. Industry analysts consider most commercial print markets
to suffer from overcapacity, leading to fierce competition. Competition is
based largely on price, quality and servicing the special needs of customers.
The company believes that demand for most product categories should continue
to improve over comparable periods in 1996. This belief may be affected by a
number of factors including: increased utilization of customer supplied paper,
which creates difficult top-line comparisons without the corresponding impact
on earnings; and movement toward increased versioning and target marketing,
which favors shorter run counts that have traditionally been more cost
effective on an offset platform. The company continues to evaluate these
factors and position of its platform configuration to ensure that it responds
to customer needs.
Recent high stock valuations and market volatility have created uncertainty
in the capital markets. The uncertainty has affected transaction flow, which
may impact results in the Financial Services business unit. Moreover, a
significant customer of the Telecommunications business unit has modified its
production cycle to move work that has been traditionally produced in the
fourth quarter into the first quarter of next year. In the short term, this
action will affect revenue and earnings comparisons in the current year. In
the long term, it should create manufacturing efficiencies as the work is
moved to slower production periods.
The company anticipates that because information systems are becoming
increasingly important to the effective management of the company, increased
spending will likely be necessary to update systems and ensure that the
company effectively manages the transition to the year 2000.
Over the past three years, the company has adopted the principles of
Economic Value Added (EVA) as its primary financial framework. The objective
of this system is to put in place a system of value-based metrics that
measures periodic progress toward improved shareholder value creation. To
enhance value, the company moved to improve its manufacturing efficiencies in
1996 by initiating the restructuring of its U.S. gravure printing platform;
the closure of its commercial print operations in the United Kingdom; and
integration of its Digital Division assets into other operations. These
actions should generate sustainable cost savings in the long-run. During 1997,
as the restructuring continues, operating efficiency will decline temporarily
due to the movement of equipment, retraining of people and movement of
printing among facilities. This short-term disruption will continue to occur
through 1997, but should provide tangible benefits in future years.
Over time, the application of the EVA financial framework to the company's
decision-making process is likely to produce slower revenue growth, enhanced
free cash flow, a stronger competitive position and improved return on
invested capital.
14
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 25, 1996, a purported class action was 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 purported class action was brought against the company
alleging age discrimination in connection with the 1993 closing of the
company's Chicago, Ill. catalog operations, and violation of the Employee
Retirement Income Security Act. These actions are described in the company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
10(a)1995 Stock Incentive Plan, as amended*
10(b)Donnelley Shares Stock Option Plan, as amended*
27Financial Data Schedule
- --------
*Management contract or compensatory plan or arrangement
(b) No current Report on Form 8-K was filed during the second quarter of
1997.
15
SIGNATURE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES 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/ Peter F. Murphy
By __________________________________
Peter F. Murphy
Corporate Controller
(Authorized Officer and
Chief Accounting Officer)
August 5, 1997
Date __________________________
16