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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(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, 1998
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 OCTOBER 31, 1998 135,807,414
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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 months ended September 30, 1998 and 1997........ 3
Condensed Consolidated Balance Sheets (Unaudited) as of
September 30, 1998 and December 31, 1997....................... 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for
the nine months ended September 30, 1998 and 1997.............. 5
Notes to Condensed Consolidated Financial Statements
(Unaudited).................................................... 6-8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Comparison of Third Quarter and First Nine Months 1998 to 1997.. 9-11
Changes in Financial Condition.................................. 11-12
Other Information............................................... 12-14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK... 14
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................ 15
ITEM 5. OTHER INFORMATION............................................ 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
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Net sales..................... $1,274,479 $1,221,743 $3,604,040 $3,479,702
Cost of sales................. 980,459 961,214 2,851,213 2,817,233
---------- ---------- ---------- ----------
Gross profit.................. 294,020 260,529 752,827 662,469
Selling and administrative
expenses..................... 145,776 126,275 419,425 376,207
---------- ---------- ---------- ----------
Earnings from operations...... 148,244 134,254 333,402 286,262
Other income (expense):
Interest expense............ (19,400) (22,079) (59,036) (67,262)
Gain on sale of Metromail
shares..................... -- -- 145,656 --
Gain on sale of DESI shares
........................... 23,247 -- 23,247 --
Other income--net........... 2,078 4,356 3,960 18,686
---------- ---------- ---------- ----------
Earnings before income taxes.. 154,169 116,531 447,229 237,686
Provision for income taxes.... 54,926 35,226 164,975 76,345
---------- ---------- ---------- ----------
Income from continuing
operations................... 99,243 81,305 282,254 161,341
Loss from discontinued
operations................... -- (9,148) (80,067) (22,168)
---------- ---------- ---------- ----------
Net income.................... $ 99,243 $ 72,157 $ 202,187 $ 139,173
========== ========== ========== ==========
Income from continuing
operations per share of
common stock:
Basic....................... $ 0.72 $ 0.56 $ 2.00 $ 1.10
Diluted..................... $ 0.71 $ 0.55 $ 1.97 $ 1.09
Loss from discontinued
operations per share of
common stock:
Basic....................... $ -- $ (0.06) $ (0.57) $ (0.15)
Diluted..................... $ -- $ (0.06) $ (0.56) $ (0.15)
Net income per share of common
stock:
Basic....................... $ 0.72 $ 0.50 $ 1.43 $ 0.95
Diluted..................... $ 0.71 $ 0.49 $ 1.41 $ 0.94
Cash dividends per basic
share........................ $ 0.21 $ 0.20 $ 0.62 $ 0.58
Average basic shares
outstanding.................. 138,075 146,192 140,982 146,086
Average diluted shares
outstanding.................. 140,247 148,507 143,212 147,719
See accompanying Notes to Condensed Consolidated Financial Statements.
3
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
------------
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(THOUSANDS OF DOLLARS)
ASSETS
1998 1997
---------- ----------
Cash and equivalents................................... $ 86,172 $ 47,814
Receivables, less allowance for doubtful accounts of
$20,366 and $16,259 at September 30, 1998 and December
31, 1997, respectively................................ 868,092 814,664
Inventories............................................ 208,540 201,402
Prepaid expenses....................................... 70,729 82,691
---------- ----------
Total current assets................................. 1,233,533 1,146,571
---------- ----------
Property, plant and equipment, at cost................. 4,313,963 4,214,765
Accumulated depreciation............................... 2,613,683 2,426,649
---------- ----------
Net property, plant and equipment.................... 1,700,280 1,788,116
Goodwill and other intangibles--net.................... 368,503 385,512
Other noncurrent assets................................ 512,602 659,260
Net assets of discontinued operations.................. 45,472 154,707
---------- ----------
Total assets......................................... $3,860,390 $4,134,166
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable....................................... $ 299,554 $ 291,666
Accrued compensation................................... 184,232 152,235
Short-term debt........................................ 45,000 45,000
Current and deferred income taxes...................... 94,233 58,888
Other accrued liabilities.............................. 285,903 264,833
---------- ----------
Total current liabilities............................ 908,922 812,622
---------- ----------
Long-term debt......................................... 1,086,239 1,153,226
Deferred income taxes.................................. 239,768 229,538
Other noncurrent liabilities........................... 337,262 347,283
Shareholders' equity:
Common stock, at stated value ($1.25 par value)...... 320,962 320,962
Retained earnings, net of cumulative translation
adjustments of $52,645 and $45,782 at September 30,
1998 and December 31, 1997, respectively............ 1,555,506 1,482,624
Unearned compensation................................ (7,183) (9,414)
Reacquired common stock, at cost..................... (581,086) (202,675)
---------- ----------
Total shareholders' equity....................... 1,288,199 1,591,497
---------- ----------
Total liabilities and shareholders' equity....... $3,860,390 $4,134,166
========== ==========
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)
1998 1997
--------- ---------
Cash flows provided by (used for) operating activities:
Net income............................................. $ 202,187 $ 139,173
Loss from discontinued operations...................... 80,067 22,168
Gain on sale of Metromail shares, net of tax........... (87,394) --
Gain on sale of DESI shares, net of tax................ (13,948) --
Depreciation........................................... 239,334 242,588
Amortization........................................... 35,683 31,563
Gain on sale of assets................................. (7,855) (15,990)
Net change in operating working capital................ (17,540) 89,995
Net change in other assets and liabilities............. 38,791 (4,838)
Other.................................................. (7,807) (2,595)
--------- ---------
Net cash provided by operating activities................ 461,518 502,064
--------- ---------
Cash flows provided by (used for) investing activities:
Capital expenditures................................... (159,083) (284,959)
Other investments...................................... (49,994) (35,171)
Dispositions of assets................................. 15,657 34,230
Disposition of Metromail shares, net of tax............ 238,438 --
Disposition of DESI shares, net of tax................. 35,641 --
--------- ---------
Net cash provided by (used for) investing activities..... 80,659 (285,900)
--------- ---------
Cash flows provided by (used for) financing activities:
Net decrease in borrowings............................. (66,987) (98,278)
Disposition of reacquired common stock................. 64,324 36,275
Acquisition of common stock............................ (443,674) (50,615)
Cash dividends on common stock......................... (86,477) (85,871)
--------- ---------
Net cash used for financing activities................... (532,814) (198,489)
--------- ---------
Effect of exchange rate changes on cash and equivalents.. (174) (239)
--------- ---------
Net increase in cash and equivalents from continuing
operations.............................................. 9,189 17,436
Net increase in cash from discontinued operations........ 29,169 8,870
Cash and equivalents at beginning of period.............. 47,814 21,317
--------- ---------
Cash and equivalents at end of period.................... $ 86,172 $ 47,623
========= =========
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 Dec. 31, 1997, 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 1997 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 and to reflect the
reclassification of operations discontinued in 1997.
Note 2. Components of the company's inventories at Sept. 30, 1998, and Dec.
31, 1997, were as follows:
(THOUSANDS OF
DOLLARS)
------------------
1998 1997
-------- --------
Raw materials and manufacturing supplies.................... $128,731 $123,280
Work in process............................................. 212,839 153,142
Finished goods.............................................. 918 1,047
Progress billings........................................... (88,070) (31,715)
LIFO reserve................................................ (45,878) (44,352)
-------- --------
Total inventories....................................... $208,540 $201,402
======== ========
Note 3. The following provides supplemental cash flow information:
(THOUSANDS OF
DOLLARS)
------------------
NINE MONTHS ENDED
SEPTEMBER 30
------------------
1998 1997
-------- --------
Interest paid, net of capitalized interest.................. $ 44,200 $ 51,000
Income taxes paid........................................... $128,437 $ 46,233
The increase in income taxes paid in the nine months ended 1998, primarily
reflects the payment of taxes resulting from the transactions described in
Notes 6 and 7 below.
Note 4. On Nov. 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 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 production operations in 1993. Other
general claims relate to other company locations. 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, and
plaintiffs have filed a motion for class certification. Both motions are
pending.
6
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On Dec. 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 Oct. 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
Aug. 14, 1997, the court denied plaintiffs' motion and 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
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 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.
Note 5. The company adopted Statement of Financial Accounting Standard No.
130, Comprehensive Income, effective for the nine months ended Sept. 30, 1998.
This statement is intended to report a measure of all changes in shareholders'
equity that result from either recognized transactions or other economic
events, excluding capital stock transactions, that impact shareholders'
equity. For the company, the only difference between net income and
comprehensive income is the effect of the increase in unrealized foreign
currency translation losses of $7 million and $13 million for the nine months
ended Sept. 30, 1998 and 1997, respectively. Comprehensive income equaled $195
million and $126 million for the nine months ended Sept. 30, 1998 and 1997,
respectively.
Note 6. Metromail Corporation, formerly a wholly-owned subsidiary of the
company, completed an initial public offering of its common stock in June
1996, reducing the company's ownership to approximately 38%. In March 1998,
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 interest in Metromail to GUS. On April 13,
1998, the company received $297 million, or approximately $238 million after-
tax, for its remaining interest in Metromail.
Note 7. Donnelley Enterprise Solutions Incorporated (DESI), formerly a
wholly-owned subsidiary of the company, completed an initial public offering
of its common stock in November 1996, reducing the company's ownership to
approximately 43%. In May 1998, DESI entered into 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. On July 7,
1998, the company received $45 million, or approximately $36 million after-tax
for its remaining interest in DESI.
7
R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note 8. In the second quarter of 1998, the company recorded an $80 million
impairment charge related to the write-down of goodwill on the books of
Corporate Software & Technologies Incorporated (CS&T) remaining from the 1995
transaction that created Stream International Holdings Inc.
CS&T is reported as a discontinued operation in the accompanying financial
statements.
Note 9. On June 30, 1998, the company issued $69 million of 8.82% debentures
due 2031 in exchange for the same amount of its 8.88% debentures due 2021. No
accounting gain or loss was recognized on this transaction.
8
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
COMPARISON OF THIRD QUARTER AND FIRST NINE MONTHS OF 1998 TO 1997
ABOUT THE COMPANY
R.R. Donnelley & Sons Company operates in a single industry segment as the
largest commercial printer in North America. The company is a leading provider
of printing and related services to the merchandising, magazine, book,
directory and financial markets. The company applies its superior skills,
scale and technology to deliver solutions that efficiently meet customers'
strategic business needs. The company has approximately 26,000 employees in 19
countries on four continents.
The commercial print industry is a large, fragmented industry consisting of
more than 52,000 firms and over 1 million employees in the United States and
generates approximately $140 billion in revenue. The company has market-
leading positions in five categories of the market served by its business
units: Merchandise Media, which serves the catalog, retail insert and direct-
mail markets; Magazine Publishing Services, which serves the consumer and the
trade and specialty magazine markets; Book Publishing Services, which serves
the trade, juvenile, educational and religious book markets;
Telecommunications, which serves the domestic and international directory
markets; and Financial Services, which serves the communication needs of the
capital markets and the mutual fund and healthcare industries. In addition to
its domestic operations, the company has operations in Europe, Latin America
and Asia.
For most of 1997, the company owned approximately 80% of Stream
International Holdings Inc. (SIH), which included three business units: 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). SIH was formed in April 1995
by a merger of the company's Global Software Services business with Corporate
Software, Inc.
In December 1997, SIH was reorganized into three separate businesses, and
the company's interest was restructured such that the company now owns 87% of
the common stock of Stream International Inc., 86% of the common stock of
Corporate Software & Technology Holdings, Inc. (CS&T) and non-voting preferred
stock of Modus Media International Holdings, Inc. (MMI). As a result of the
restructuring and the company's intention to dispose of its interest in CS&T,
the company has reported its interests in CS&T and MMI as discontinued
operations and reclassified the prior years' consolidated financial results.
The financial results of Stream International are reported in the consolidated
results of the company's continuing operations.
Sales results by business unit for the third quarter and first nine months
of 1998 and 1997 are presented below:
NET SALES BY BUSINESS UNIT
THIRD QUARTER ENDED SEPTEMBER
30,
(THOUSANDS OF DOLLARS) 1998 % OF TOTAL 1997 % OF TOTAL
----------------------------- ---------- ---------- ---------- ----------
Merchandise Media............. $ 335,247 26% $ 335,137 27%
Magazine Publishing Services.. 339,982 27% 322,566 26%
Book Publishing Services...... 202,379 16% 203,211 17%
Telecommunications............ 198,615 16% 182,125 15%
Financial Services............ 133,235 10% 119,896 10%
Other......................... 65,021 5% 58,808 5%
---------- ---- ---------- ----
$1,274,479 100% $1,221,743 100%
========== ==== ========== ====
9
NET SALES BY BUSINESS UNIT--YEAR TO DATE
NINE MONTHS ENDED SEPTEMBER 30, % OF % OF
(THOUSANDS OF DOLLARS) 1998 SALES 1997 SALES
- ------------------------------- ---------- ----- ---------- -----
Merchandise Media............................. $ 905,199 25% $ 910,789 26%
Magazine Publishing Services.................. 984,030 27% 932,157 27%
Book Publishing Services...................... 546,315 15% 556,376 16%
Telecommunications............................ 564,146 16% 526,182 15%
Financial Services............................ 403,021 11% 367,483 11%
Other......................................... 201,329 6% 186,715 5%
---------- ---- ---------- ----
$3,604,040 100% $3,479,702 100%
========== ==== ========== ====
CONSOLIDATED RESULTS OF OPERATIONS
The company reported income from continuing operations [excluding the gain
on the sale of the company's remaining interest in Donnelley Enterprise
Solutions Incorporated (DESI)] for the third quarter of 1998 of $85 million,
or 61 cents per diluted share, compared with $81 million, or 55 cents per
diluted share, in the third quarter of 1997. Including the DESI gain and last
year's loss from discontinued operations, net income for the third quarter of
1998 was $99 million, or 71 cents per diluted share, compared with $72
million, or 49 cents per diluted share, in the third quarter of 1997.
For the first nine months of 1998, the company reported income from
continuing operations (excluding gain on the sale of the company's remaining
interest in Metromail Corporation and the DESI gain) of $181 million, or $1.26
per diluted share, compared with $161 million, or $1.09 per diluted share, in
1997's first nine months. Including the Metromail and DESI gains and losses
from discontinued operations, net income rose by 45 percent to $202 million,
or $1.41 per diluted share, from $139 million or 94 cents per diluted share, a
year earlier.
CONSOLIDATED NET SALES
Net sales for the third quarter of 1998 increased by $53 million, or 4.3
percent, to $1.3 billion. Magazine Publishing Services increased due to
relatively strong demand across most product categories. Telecommunications
increased as a result of increased advertising demand. Financial Services
increased due to the strength of the capital markets early in the quarter.
Merchandise Media increased slightly from the third quarter of 1997. Third
quarter 1998 sales for this business unit reflected the production of fewer
retail inserts and changes initiated in paper purchasing activities, which
reduced net sales and material costs. Book Publishing Services declined due to
weakness in the four-color trade market and a reduction in the company's
distribution and fulfillment activities.
Net sales for the first nine months increased by $124 million, or 3.6
percent, to $3.6 billion. Magazine sales were higher, reflecting strong
advertising. Telecommunication sales were higher reflecting a significant
customer's change in production cycle to move directory titles from the fourth
quarter of 1997 to the first quarter of 1998, and Financial Services' sales
were higher resulting from the strength of the capital markets.
Excluding materials (principally paper and ink), sales increased by 5.8
percent for the third quarter and 4.6 percent for the first nine months,
reflecting the expanded scope of value-added services provided by the company.
CONSOLIDATED EXPENSES
Gross profit in the third quarter of 1998 increased 13% to $294 million and
in the first nine months of 1998 increased 14% to $753 million, due to lower
costs driven by the benefit of restructuring activities begun in 1997 and the
company's focus on continuous productivity improvement, as well as
improvements in the operations of the logistics and fulfillment businesses. In
addition, in the previous year's first nine months, the company incurred
higher expenses associated with the development of the company's logistics and
fulfillment businesses and the startup of a Roanoke, Va., four-color short run
book plant.
10
Selling and administrative expenses for the third quarter of 1998 increased
15% to $146 million, due to increases in volume and information systems-
related expenditures. The ratio of selling and administrative expenses to net
sales was 11.4% for the third quarter of 1998 and 10.3% for the third quarter
of 1997. Earnings from operations increased by 10% to $148 million,
corresponding to an improvement in operating margins from 11.0% to 11.6% of
net sales.
Selling and administrative expenses in the first nine months of 1998
increased 11% to $419 million due to volume increases, increases in
information systems-related expenditures and higher Stream International
expenditures. The ratio of selling and administrative expenses to net sales
was 11.6% for the first nine months of 1998 and 10.8% in the first nine months
of 1997. Earnings from operations increased 16% to $333 million. The operating
margin widened to 9.3% from 8.2% a year earlier.
SUMMARY OF EXPENSE TRENDS
THIRD QUARTER ENDED
SEPTEMBER 30, % INCREASE
(THOUSANDS OF DOLLARS) 1998 1997 (DECREASE)
---------------------- ----------- ---------- ---------- --- --- ---
Cost of materials........... $ 478,068 $ 468,902 2.0%
Cost of manufacturing....... 403,965 394,804 2.3%
Depreciation................ 81,193 87,101 (6.8)%
Amortization................ 17,233 10,407 65.6%
Selling and administrative.. 145,776 126,275 15.4%
Net interest expense........ 19,400 22,079 (12.1)%
NINE MONTHS ENDED SEPTEMBER
30, % INCREASE
(THOUSANDS OF DOLLARS) 1998 1997 (DECREASE)
--------------------------- ----------- ---------- ----------
Cost of materials........... $ 1,360,153 $1,335,126 1.9%
Cost of manufacturing....... 1,216,043 1,207,956 0.7%
Depreciation................ 239,334 242,588 (1.3)%
Amortization................ 35,683 31,563 13.1%
Selling and administrative.. 419,425 376,207 11.5%
Net interest expense........ 59,036 67,262 (12.2)%
NONOPERATING ITEMS
Interest expense decreased approximately $3 million in the quarter and $8
million in the first nine months of 1998 due to lower average debt balances
associated with improved balance sheet management. Other income declined
approximately $2 million in the quarter due to a gain, in the third quarter of
1997, on the sale of non-core investments. Other income declined approximately
$15 million in the first nine months of 1998 due to non-recurring gains in
1997 on the sale of the company's interest in a magazine distribution venture
in the United Kingdom and the sale of other non-core investments.
DISCONTINUED OPERATIONS
The operations of MMI and CS&T are reported as discontinued operations in
conjunction with the restructuring of the company's ownership interest in SIH,
as discussed above. Results for the first nine months of 1998 include an $80
million impairment charge related to the write-down of goodwill on the books
of CS&T. Results for the third quarter and first nine months of 1997 include
losses from discontinued operations of $9 million and $22 million,
respectively.
CHANGES IN FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
For the first nine months of 1998, net cash flow provided by operating
activities was $462 million, down $41 million from last year's first nine
months. Increased net income was offset by a decline in cash provided from
operating working capital (defined as inventories, accounts receivable and
prepaid expenses, minus accounts payable, accrued compensation and other
accrued liabilities) predominantly
11
due to an increase in receivables on the higher sales, and the payment of
incentive compensation. Capital expenditures totaled $159 million for the
first nine months of 1998 compared with $285 million spent in the first nine
months of 1997. Spending was focused on projects that are expected to further
enhance productivity. Full-year capital spending is expected to be
approximately $270 million. Management believes that the company's cash flow
and borrowing capacity are sufficient to fund current operations and growth.
At Sept. 30, 1998, 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.
OTHER INFORMATION
Share repurchase--In January 1998, the board of directors authorized a
program to repurchase up to $500 million of the company's common stock in
privately negotiated or open-market transactions over an 18-month period. The
program includes shares purchased for issuance under various stock option
plans. On Sept. 24, 1998, the board of directors approved a new, $300 million
stock repurchase program, which augments the $500 million repurchase program
announced in January 1998.
The company utilized proceeds from the sale of its remaining interests in
Metromail and DESI to support the share buyback. During the first nine months
of the year, the company purchased approximately 10.6 million shares, at an
average price of $41.72 per share.
Technology--The company remains a technology leader, investing not only in
print-related technologies, such as computer-to-plate and digital printing,
but also in areas such as distribution of content and images over the
Internet. Technology is applied to enhance customers' products across the
entire manufacturing process. The company's recent investments have been
focused on development of a digital platform to support the movement of work
from customers' desktops across the company's manufacturing process, enabling
output in multiple media. The company is focused on investing in technologies
that contribute to its financial performance and help it deliver products,
services and solutions its competitors cannot easily duplicate.
Process control and information systems are becoming increasingly important
to the effective management of the company. Increased spending on new systems
and updating of existing systems will be necessary. In 1998 and 1999, these
efforts will be focused on ensuring that processes and systems are Year 2000
compliant. In addition, the company is focused on an initiative to upgrade and
standardize the company's information technology infrastructure, which has the
incidental effect of addressing certain of the company's Year 2000 compliance
issues. The company is deferring a number of other infrastructure and systems
initiatives that would support continuous productivity improvements and
enhanced service capabilities until after the company completes its Year 2000
efforts.
The Year 2000 compliance issues stem from the computer industry's practice
of conserving data storage by using two digits 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.
The company's effort to address Year 2000 compliance issues in its core
business includes (i) evaluating internal computing infrastructure, business
applications and shop-floor systems for Year 2000 compliance (ii) replacing or
renovating systems and applications as necessary to assure such compliance,
and (iii) testing the replaced or renovated systems and applications. The
company's efforts in these respects are well under way, and the company
currently expects that all phases of such efforts will be completed by mid-
1999. In addition to its internal remediation activities, the company is
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continuing to evaluate compliance by key suppliers and vendors and other
external companies, including customers whose systems interact with those of
the company. The company expects to substantially complete this evaluation in
early 1999. Separate Year 2000 compliance programs are in progress at Stream
International and CS&T, which is classified as discontinued.
Although the company expects its internal systems to be Year 2000 compliant
as described above, the company intends to prepare a contingency plan that
will specify what it plans to do if critical systems, processes, suppliers,
vendors and external companies encounter Year 2000 issues. The company expects
to have an initial contingency plan finalized by March 31, 1999, and to update
it from time to time as developments warrant.
Company employees, assisted by the expertise of external consultants where
necessary, staff the Year 2000 compliance efforts. Management expects to spend
approximately $40 million for all of 1998 in connection with its Year 2000
initiative, of which approximately $30 million has been spent through the
third quarter of 1998. Management expects that expenses will be similar for
1999. These estimated expenses do not include costs being capitalized with
respect to the company's information and technology infrastructure upgrade and
standardization initiative or estimated costs associated with Year 2000
initiatives at Stream International or CS&T.
Litigation--On Nov. 25, 1996, a purported class action was brought against
the company in federal district court in Chicago, Ill., on behalf of 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 production operations begun in 1993.
Other general claims relate to other company locations. 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 and
plaintiffs have filed a motion for class certification. Both motions are
pending.
On Dec. 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 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 terminating employees.
On Oct. 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
Aug. 14, 1997, the court denied plaintiffs' motion and 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
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 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
13
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.
Environmental Regulations--The company is subject to various laws and
regulations relating to employee health and safety and to environmental
protection. The company's policy is to be in compliance with all such laws and
regulations that govern protection of the environment and employee health and
safety. The company does not anticipate that compliance with such
environmental, safety and health laws and regulations will have a material
adverse effect upon the company's competitive or consolidated financial
position.
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 of the commercial
printing markets to suffer from overcapacity, and competition, therefore, is
fierce. Competition is based largely on price, quality and servicing the
special needs of customers.
The company is a large consumer of paper, acquired for customers and by
customers. The cost and supply of certain paper grades consumed in the
manufacturing process will continue to affect the company's financial results.
Management currently does not foresee any disruptive conditions affecting
prices and supply of paper in 1998.
Postal costs are a significant component of the cost structure of the
customers of the company. Changes in postal rates in 1999 are expected to be
manageable for most key customer segments.
Additionally, proposed changes to the Postal Service's legislative charter
also could affect the postal communication and commerce environment. While the
proposed legislative changes are controversial, aspects of the proposal could
strengthen the company's position as a postal intermediary. Even in the
absence of legislative reform, the company's ability to improve the cost
efficiency of mail processing and distribution will enhance its position in
the postal business 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 next year's business
environment. The company's financial printing business unit has performed well
to date but is primarily dependent on capital market activity.
Management believes the company's competitive strengths--including its
comprehensive service offerings, depth of customer relationships, technology
leadership, management experience and economies of scale--should result in
profitable growth throughout 1998 and well into the future.
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The company is exposed to market risk from changes in interest rates and
foreign exchange rates. However, since the majority of the company's debt is
at fixed interest rates, the company's exposure to interest rate fluctuations
is immaterial to the consolidated financial statements of the company as a
whole. The company's exposure to adverse changes in foreign exchange rates is
also immaterial to the consolidated financial statements of the company as a
whole, although the company occasionally uses financial instruments to hedge
what exposure to foreign exchange rate changes it may have. The company does
not use financial instruments for trading purposes and is 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 the company's 1997 annual report
on Form 10-K.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On each of June 30, 1998, and Nov. 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 Dec. 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 part I of this
quarterly report on Form 10-Q.
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 1997 Annual Report on Form 10-K for a
description of such factors.
The company's expectation to be Year 2000 compliant in a timely manner and
at the costs described could be adversely affected by several factors,
including the ability of the company to attract and retain trained personnel
or third-party suppliers in this area, the costs to do so, and the ability to
identify and correct systems or applications that require remediation. The
failure of the company to achieve Year 2000 compliance or the failure of its
key suppliers, vendors or customers to achieve Year 2000 compliance in a
timely manner could have a material adverse effect on the company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
10(a) Retirement Policy for Directors, as amended
10(b) Directors' Deferred Compensation Agreement, as amended
10(c) Senior Management Incentive Plan, as amended
10(d) 1995 Stock Incentive Plan, as amended
10(e) Form of option agreement with non-employee directors, as amended
27 Financial Data Schedule
(b) NO CURRENT REPORT ON FORM 8-K WAS FILED DURING THE THIRD QUARTER OF
1998.
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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/ Peter F. Murphy
By __________________________________
Corporate Controller
(Authorized Officer and
Chief Accounting Officer)
November 12, 1998
Date __________________________
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