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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, 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 SEPTEMBER 30, 1997 145,867,433
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAGE
INDEX NUMBER(S)
----- ---------
Condensed Consolidated Statements of Income (Unaudited) for the
three and nine month periods ended September 30, 1997 and
1996.......................................................... 3
Condensed Consolidated Balance Sheets as of September 30, 1997
(Unaudited) and December 31, 1996............................. 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for
the nine months ended September 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 Third Quarter and First Nine Months 1997 to 1996. 8-11
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
Net sales............... $ 1,557,349 $ 1,592,790 $ 4,537,584 $ 4,697,316
Cost of sales........... 1,257,461 1,309,608 3,754,436 3,883,249
------------ ------------ ------------ ------------
Gross profit............ 299,888 283,182 783,148 814,067
Selling and
administrative
expenses............... 174,426 157,419 528,151 520,692
Restructuring charges... -- -- -- 560,632
------------ ------------ ------------ ------------
Earnings (loss) from
operations............. 125,462 125,763 254,997 (267,257)
Other income (expense):
Interest expense....... (22,079) (21,818) (67,262) (71,614)
Gain on Metromail stock
offering............... -- -- -- 44,158
Other income
(expense)--net......... 8,490 1,198 28,039 30,757
------------ ------------ ------------ ------------
Earnings (loss) before
income taxes........... 111,873 105,143 215,774 (263,956)
Provision (benefit) for
income taxes........... 39,715 37,275 76,600 (9,182)
------------ ------------ ------------ ------------
Net income (loss)....... $ 72,158 $ 67,868 $ 139,174 $ (254,774)
============ ============ ============ ============
Per common share:
Net income (loss)..... $ 0.49 $ 0.45 $ 0.95 $ (1.66)
============ ============ ============ ============
Cash dividends........ $ 0.20 $ 0.19 $ 0.58 $ 0.55
============ ============ ============ ============
Average shares
outstanding............ 146,192,000 152,444,000 146,086,000 153,416,000
============ ============ ============ ============
See accompanying Notes to Condensed Consolidated Financial Statements.
3
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
------------
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(THOUSANDS OF DOLLARS)
ASSETS
1997 1996
----------- -----------
Cash and equivalents................................. $ 66,462 $ 31,142
Receivables, less allowance for doubtful accounts of
$42,119 and $24,735 at September 30, 1997 and
December 31, 1996, respectively..................... 1,145,852 1,324,252
Inventories.......................................... 299,571 288,506
Prepaid expenses..................................... 117,653 108,957
----------- -----------
Total current assets............................... 1,629,538 1,752,857
----------- -----------
Property, plant and equipment, at cost............... 4,452,690 4,289,101
Accumulated depreciation............................. (2,485,486) (2,344,374)
----------- -----------
Net property, plant and equipment.................. 1,967,204 1,944,727
Goodwill and other intangibles--net.................. 498,361 541,319
Other noncurrent assets.............................. 662,526 610,101
----------- -----------
Total assets....................................... $ 4,757,629 $ 4,849,004
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable..................................... $ 459,551 $ 487,914
Accrued compensation................................. 187,644 131,644
Short-term debt...................................... 33,296 33,296
Current and deferred income taxes.................... 81,884 56,163
Other accrued liabilities............................ 342,729 438,530
----------- -----------
Total current liabilities.......................... 1,105,104 1,147,547
----------- -----------
Long-term debt....................................... 1,330,919 1,430,671
Deferred income taxes................................ 251,908 253,850
Other noncurrent liabilities......................... 411,013 385,655
Shareholders' equity:
Common stock, at stated value ($1.25 par value).... 320,962 320,962
Retained earnings, net of cumulative translation
adjustments of $36,550 and $26,580 at September
30, 1997 and December 31, 1996, respectively...... 1,523,941 1,486,215
Unearned compensation.............................. (10,780) (5,402)
Reacquired common stock, at cost................... (175,438) (170,494)
----------- -----------
Total shareholders' equity..................... 1,658,685 1,631,281
----------- -----------
Total liabilities and shareholders' equity..... $ 4,757,629 $ 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 NINE MONTHS ENDED SEPTEMBER 30
(THOUSANDS OF DOLLARS)
1997 1996
--------- ---------
Cash flows provided by (used for) operating activities:
Net income (loss)...................................... $ 139,174 $(254,774)
Restructuring charge, net of tax and minority interest. -- 435,380
Depreciation........................................... 258,200 256,995
Amortization........................................... 34,125 43,112
Gain on Metromail stock offering....................... -- (44,158)
Gains on sales of assets............................... (16,028) (16,310)
Net change in operating working capital................ 117,481 118,882
Net change in other assets and liabilities............. 20,132 (19,230)
Other.................................................. (5,205) 2,488
--------- ---------
Net cash provided by operating activities................ 547,879 522,385
--------- ---------
Cash flows provided by (used for) investing activities:
Capital expenditures................................... (321,746) (321,675)
Proceeds from receivables from Metromail............... -- 248,510
Other investments including acquisitions, net of cash
acquired.............................................. (47,826) (22,278)
Dispositions of assets................................. 59,306 18,068
--------- ---------
Net cash used for investing activities................... (310,266) (77,375)
--------- ---------
Cash flows provided by (used for) financing activities:
Net decrease in borrowings............................. (99,751) (246,603)
Disposition of reacquired common stock................. 36,275 32,420
Acquisition of common stock............................ (52,205) (157,887)
Cash dividends on common stock......................... (85,871) (84,597)
--------- ---------
Net cash used for financing activities................... (201,552) (456,667)
--------- ---------
Effect of exchange rate changes on cash and equivalents.. (741) 102
--------- ---------
Net increase (decrease) in cash and equivalents.......... 35,320 (11,555)
--------- ---------
Cash and equivalents at beginning of period.............. 31,142 33,122
--------- ---------
Cash and equivalents at end of period.................... $ 66,462 $ 21,567
========= =========
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 September 30, 1997 and
December 31, 1996 were as follows:
(THOUSANDS OF
DOLLARS)
------------------
1997 1996
-------- --------
Raw materials and manufacturing supplies.................... $150,934 $154,734
Work in process............................................. 228,740 183,248
Finished goods.............................................. 26,439 34,325
Progress billings........................................... (61,716) (40,475)
LIFO reserve................................................ (44,826) (43,326)
-------- --------
Total inventories....................................... $299,571 $288,506
======== ========
Note 3. The following provides supplemental cash flow information:
(THOUSANDS OF
DOLLARS)
------------------
NINE MONTHS ENDED
SEPTEMBER 30
------------------
1997 1996
-------- --------
Cash flow data:
Interest paid, net of capitalized interest................. $ 51,000 $ 54,927
Income taxes paid.......................................... $ 46,233 $ 56,845
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 the 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 through 1998, of which $87 million was incurred
prior to September 30, 1997. 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.
6
The following table presents the components of the company's restructuring
reserves along with charges against these reserves from their establishment
until September 30, 1997 (in thousands of dollars):
WRITEDOWN OF
PROPERTY AND
ORIGINAL INVESTMENTS RESTRUCTURING
RESTRUCTURING TO FAIR CASH RESERVES AS OF
RESERVES VALUE PAYMENTS SEPTEMBER 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 -- (86,500) 90,460
Impairment loss on
intangible assets and
investments............ 132,941 (132,941) -- --
-------- --------- -------- -------
Total restructuring
reserves........... $560,632 $(383,672) $(86,500) $90,460
======== ========= ======== =======
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. On August 14, 1997, the court
denied plaintiffs' motion and ruled that the proper ERISA class is limited to
the former Chicago employees. On September 4, 1997, plaintiffs filed a motion
to reconsider the court's ruling.
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
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
COMPARISON OF THIRD QUARTER AND FIRST NINE MONTHS 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.
On October 21, 1997, the company announced a reorganization of its business
structure. The new structure merges the previous sectors--Commercial Print
Sector, Information Management Sector and Global Commercial Print Sector--into
one central organization.
The company is now organized into five business units: Merchandise Media
(servicing catalog, retail advertising and direct mail markets), Magazine
Publishing Services, Book Publishing Services, Telecommunications (servicing
domestic and international telephone directory markets) and Financial
Services.
The company's operations in Europe and Latin America will continue to be
managed on a geographic basis.
In addition, the company owns approximately 80% of 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.
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. 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 and
will be named Stream International Inc. SIH's two other business units,
Corporate Software & Technology and Modus Media International, would be spun
off and the equity would be distributed to the current SIH stockholders. After
completion of the reorganization and public offering, the company would own
less than 50% of the outstanding shares of Stream International. It would
account for its interest in Stream International and in the remaining
businesses as investments. The planned offering of Stream International shares
will be made only by means of a prospectus.
8
Sales results by business unit for the third quarter and first nine months
of 1997 and 1996 are presented below:
NET SALES BY BUSINESS UNIT--THIRD QUARTER
THIRD QUARTER ENDED SEPTEMBER
30,
(THOUSANDS OF DOLLARS) 1997 % OF TOTAL 1996 % OF TOTAL
----------------------------- ---------- ---------- ---------- ----------
Stream International Holdings,
Inc............................ $ 392,029 25.2% $ 382,604 24.0%
Merchandise Media............... 323,130 20.7% 348,902 21.9%
Magazine Publishing Services.... 281,330 18.1% 273,874 17.2%
Book Publishing Services........ 215,219 13.8% 198,895 12.5%
Telecommunications.............. 146,320 9.4% 166,919 10.5%
Financial Services.............. 119,896 7.7% 103,033 6.5%
Global Commercial Print......... 77,041 4.9% 85,326 5.4%
Other........................... 2,384 0.2% 33,237 2.0%
---------- ----- ---------- -----
$1,557,349 100.0% $1,592,790 100.0%
========== ===== ========== =====
NET SALES BY BUSINESS UNIT--YEAR TO DATE
NINE MONTHS ENDED SEPTEMBER 30,
(THOUSANDS OF DOLLARS) 1997 % OF TOTAL 1996 % OF TOTAL
------------------------------- ---------- ---------- ---------- ----------
Stream International Holdings,
Inc............................ $1,228,852 27.1% $1,178,238 25.0%
Merchandise Media............... 876,856 19.3% 928,397 19.8%
Magazine Publishing Services.... 811,935 17.9% 803,621 17.1%
Book Publishing Services........ 590,308 13.0% 540,415 11.5%
Telecommunications.............. 415,214 9.2% 480,135 10.2%
Financial Services.............. 367,483 8.1% 305,426 6.5%
Global Commercial Print......... 232,637 5.1% 242,432 5.2%
Metromail Corporation........... -- 0.0% 125,522 2.7%
Other........................... 14,299 0.3% 93,130 2.0%
---------- ----- ---------- -----
$4,537,584 100.0% $4,697,316 100.0%
========== ===== ========== =====
CONSOLIDATED RESULTS OF OPERATIONS
The company reported third quarter 1997 net income of $72 million, a 6%
increase from last year's third quarter. Earnings per share increased $0.04 to
$0.49. Third quarter net sales of $1.6 billion were down 2% from the year-
earlier quarter.
Results for the 1997 quarter reflect the decision by Metromail Corporation,
in which the company has a 38% ownership interest, to expense as in-process
research and development $23 million pre-tax ($13.8 million after tax) of the
purchase price of Saxe, Inc., which Metromail acquired in the third quarter.
Excluding the effect of Metromail's write-down, third quarter earnings totaled
$75 million, or $0.51 per share, a 13% increase in earnings per share from the
previous year's quarter.
For the first nine months of 1997, the company reported net income of $139
million, or $0.95 per share. In the previous year's nine-month period, the
company reported a net loss of $255 million, or $1.66 per share, reflecting
the $561 million in pre-tax restructuring charges ($435 million after taxes
and a minority interest benefit), primarily to realign gravure operations in
North America and to reposition SIH. These charges were partially offset by a
$44 million pre-tax gain ($26 million after taxes) on the initial public
offering of Metromail common shares. Excluding the restructuring charges and
the Metromail gain, net income for the first nine months of 1996 totaled $154
million, or $1.01 per share.
9
Year-to-date net income and earnings per share declined 10% and 6%,
respectively, from last year's first nine months, excluding the restructuring
charges and the Metromail gain. The company's performance in the first nine
months 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 third quarter of 1997 decreased approximately $35 million,
or 2%, to approximately $1.6 billion. The decline was principally due to
decreases in the cost of materials (primarily paper) in Merchandise Media and
Telecommunications and declines in Global Commercial Print due to the
discontinuation of commercial printing in the United Kingdom. These declines
were partially offset by increased volume in most business units.
Net sales from foreign operations represented approximately $244 million, or
16% of total net sales in the third quarter, up 2% from $239 million, or 15%
of total net sales in the year-earlier quarter.
Net sales for the first nine months of 1997 decreased $160 million, or 3%,
to approximately $4.5 billion. The decline was primarily due to the factors
identified above, as well as price and volume declines in Telecommunications
and the company's deconsolidation of Metromail as a result of reduced
ownership following the second quarter 1996 public offering. These declines
were partially offset by increased demand in most business units.
Net sales from foreign operations represented approximately $747 million, or
17% of total net sales in the first nine months of 1997, down 2% from $765
million, or 16% of total net sales in the first nine months of 1996. The
decline in foreign sales reflects the discontinuation of commercial printing
in the United Kingdom and the worldwide repositioning of SIH's international
operations.
CONSOLIDATED EXPENSES
Cost of sales for the third quarter decreased $52 million, or 4%, to $1.3
billion primarily as a result of the material declines discussed above. Gross
profit in the third quarter of 1997 increased 6% to $300 million.
Cost of sales for the first nine months of 1997 decreased $129 million, or
3%, to $3.8 billion. Gross profit for the first nine months of 1997 declined
4% to $783 million due to the company's reduced ownership of Metromail, price
and volume declines in Telecommunications and higher expenses associated with
the 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 first half of
the year. These declines were partially offset by manufacturing cost
improvements in most business units.
Selling and administrative expenses in the third quarter of 1997 increased
11% to $174 million, due to the volume increases in most business units and
the increased cost of operating SIH as three separate businesses. Other income
in the third quarter of 1997 increased $7 million due primarily to the
decrease in cost of the company's corporate-owned life insurance program
resulting from discontinuation of premium payments, as well as gains on the
sale of investments in the company's venture-capital portfolio, partially
offset by the impact of the writedown by Metromail discussed above.
Selling and administrative expenses in the first nine months of 1997
increased 1% to $528 million, due to the factors identified above. Interest
expense decreased approximately $4 million, due to lower average debt balances
associated with improvements in operating working capital and the reduction
10
of debt using a portion of the proceeds of the public offering of Donnelley
Enterprise Solutions Incorporated (DESI). Other income for the first nine
months of 1997 decreased $3 million, primarily due to non-recurring events in
the first nine months of 1996, including a $14 million gain on the sale of
investments in the company's venture-capital portfolio and a $17 million
minority interest benefit arising from SIH's portion of the restructuring
charges. These non-recurring events were offset by a $6 million gain on the
sale of the company's interest in a magazine distribution venture in the
United Kingdom, gains on the sale of investments in the company's venture-
capital portfolio and the other factors identified above for the quarter.
SUMMARY OF EXPENSE TRENDS
THIRD QUARTER ENDED SEPTEMBER
30, % INCREASE
(THOUSANDS OF DOLLARS) 1997 1996 (DECREASE)
---------------------- ---------- ---------- ---------- --- --- ---
Cost of materials............ $ 720,096 $ 765,844 (6.0%)
Cost of manufacturing........ 436,623 453,420 (3.7%)
Depreciation................. 86,356 80,387 7.4%
Amortization................. 14,386 9,957 44.5%
Selling and administrative... 174,426 157,419 10.8%
Net interest expense......... 22,079 21,818 1.2%
NINE MONTHS ENDED SEPTEMBER
30, % INCREASE
(THOUSANDS OF DOLLARS) 1997 1996 (DECREASE)
---------------------- ---------- ---------- ---------- --- --- ---
Cost of materials............ $2,120,571 $2,227,079 (4.8%)
Cost of manufacturing........ 1,341,540 1,356,063 (1.1%)
Depreciation................. 258,200 256,995 0.5%
Amortization................. 34,125 43,112 (20.8%)
Selling and administrative... 528,151 520,692 1.4%
Net interest expense......... 67,262 71,614 (6.1%)
RESULTS OF OPERATIONS OF PRINT-RELATED BUSINESSES AND 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 third
quarter of 1997 decreased $45 million to $1.2 billion. The decline was
principally due to decreases in material costs (primarily paper) in
Merchandise Media and Telecommunications and declines in Global Commercial
Print due to the discontinuation of commercial printing in the United Kingdom.
These declines were partially offset by increased demand in most business
units. Print-related businesses had operating income of $133 million in the
third quarter of 1997, a $1 million decrease from the third quarter of 1996.
For the first nine months of 1997, net sales declined $85 million to $3.3
billion. The decline primarily reflects the factors identified above.
Operating income for the first nine months of 1997 was $281 million, a 6%
decline from the first nine months of 1996, excluding the 1996 restructuring
charge. The decline is attributable to higher expenses associated with the
development of the company's logistics and fulfillment businesses, the startup
of the Roanoke facility, and price and volume declines in Telecommunications.
SIH
Net sales for SIH in the third quarter 1997 increased by $9 million, or 2%,
to $392 million. SIH had an operating loss of approximately $8 million, a $1
million improvement over the third quarter of 1996.
For the first nine months of 1997, net sales increased by $51 million, or
4%, to $1.2 billion. For the period, SIH had an operating loss of $26 million,
a $7 million decline from the first nine months of 1996. The decline is
attributable to the cost of operating SIH as three separate businesses and an
additional bad debt reserve recorded in the first quarter of 1997.
11
CHANGES IN FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
For the first nine months of 1997, net cash flow provided by operating
activities increased by $25 million, or 5%, to $548 million. Reductions in
operating working capital (defined as inventories, accounts receivable and
prepaid expenses, minus accounts payable, accrued compensation and other
accrued liabilities, including the restructuring reserve) provided cash of
$117 million compared to $119 million for the first nine months of 1996.
Management believes that the company's cash flow and borrowing capacity are
sufficient to fund current operations and growth. Capital expenditures totaled
$79 million and $322 million for the third quarter and first nine months of
1997, respectively, including purchases for the new short-run four-color book
facility and purchases related to revamping the company's gravure
manufacturing platform. Full-year capital spending is expected to be
approximately $450 million.
At September 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 $110 million at September 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 $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.
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 ($87 million of this amount has been paid
through September 30, 1997). The remaining $383 million relates to non-cash
items, mainly the write-down of fixed assets and goodwill.
12
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.
In July 1997, the company announced plans to close a fulfillment and
distribution center in Crawfordsville, Ind. and plans to close Coris, a
content-management software subsidiary in Willowbrook, Ill. Both closings,
which may include the sale of certain assets, are expected to occur by the end
of 1997. Costs associated with the closings are not expected to have a
material effect on the company's financial results.
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. On August 14, 1997, the court denied
plaintiffs' motion and ruled that the proper ERISA class is limited to the
former Chicago employees. On September 4, 1997, plaintiffs filed a motion to
reconsider the court's ruling.
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 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 average number of outstanding shares was 146 million and 153
million in the first nine months of 1997 and 1996, respectively.
13
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. 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 trend provides challenges for the company, which include the availability
of offset capacity in the last quarter of the year and utilization of existing
gravure capacity. The company continues to evaluate these factors and position
its platform configuration to ensure that it responds to customer needs.
Within Book Publishing Services, one- and two-color trade books have shown
some weakness, as publishers develop their fourth quarter manufacturing plans
and attempt to adjust to the changing dynamics of the publishing industry. The
company is beginning to see shifts in print orders as publishers attempt to
reduce returns. This dynamic will lead to a lower growth rate in the fourth
quarter than the company has experienced in the first nine months of the year
and will continue to impact demand in the future.
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; closing of
its commercial print operations in the United Kingdom; and integrating 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.
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
3(ii)(a) By-Laws
3(ii)(b) Amendment to By-Laws adopted September 25, 1997.
27 Financial Data Schedule
- --------
(b) No current Report on Form 8-K was filed during the third 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)
October 28, 1997
Date __________________________
16