-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VvDSv3u6BQAny9USkFTepEgEOEzyzGPe+QgKV81pjJW0O/CQH9GbrfOlta3d14CQ D54lOzxX/9BBTvw/x6/jmQ== 0000950131-98-004839.txt : 19980817 0000950131-98-004839.hdr.sgml : 19980817 ACCESSION NUMBER: 0000950131-98-004839 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: CSX SROS: NYSE SROS: PCX FILER: COMPANY DATA: COMPANY CONFORMED NAME: DONNELLEY R R & SONS CO CENTRAL INDEX KEY: 0000029669 STANDARD INDUSTRIAL CLASSIFICATION: COMMERCIAL PRINTING [2750] IRS NUMBER: 361004130 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-04694 FILM NUMBER: 98688219 BUSINESS ADDRESS: STREET 1: 77 W WACKER DR CITY: CHICAGO STATE: IL ZIP: 60601 BUSINESS PHONE: 3123268000 MAIL ADDRESS: STREET 1: 77 W WACKER DRIVE CITY: CHICAGO STATE: IL ZIP: 60601 10-Q 1 FORM 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------- FORM 10-Q ----------- (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 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 JULY 31, 1998 139,150,410 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
PAGE INDEX NUMBER(S) ----- --------- Condensed Consolidated Statements of Income (Unaudited) for the three and six months ended June 30, 1998 and 1997.............. 3 Condensed Consolidated Balance Sheets (Unaudited) as of June 30, 1998 and December 31, 1997..................................... 4 Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 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 Second Quarter and First Half 1998 to 1997........ 9-11 Changes in Financial Condition.................................. 11-12 Subsequent Event................................................ 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 SIX MONTHS ENDED JUNE 30 JUNE 30 ---------------------- ---------------------- 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Net sales..................... $1,143,583 $1,136,775 $2,304,979 $2,239,422 Cost of sales................. 902,835 927,938 1,846,172 1,837,482 ---------- ---------- ---------- ---------- Gross profit.................. 240,748 208,837 458,807 401,940 Selling and administrative expenses..................... 143,429 129,154 273,649 249,932 ---------- ---------- ---------- ---------- Earnings from operations...... 97,319 79,683 185,158 152,008 Other income (expense): Interest expense............ (19,689) (22,622) (39,636) (45,182) Gain on sale of Metromail shares..................... 145,656 -- 145,656 -- Other income--net........... 1,764 9,624 1,881 14,329 ---------- ---------- ---------- ---------- Earnings before income taxes.. 225,050 66,685 293,059 121,155 Provision for income taxes.... 86,246 21,727 110,049 41,119 ---------- ---------- ---------- ---------- Income from continuing operations................... 138,804 44,958 183,010 80,036 Loss from discontinued operations................... (80,067) (7,282) (80,067) (13,019) ---------- ---------- ---------- ---------- Net income.................... 58,737 37,676 102,943 67,017 ========== ========== ========== ========== Income from continuing operations per share of common stock: Basic....................... $ 0.99 $ 0.31 $ 1.28 $ 0.55 Diluted..................... $ 0.97 $ 0.30 $ 1.26 $ 0.54 Loss from discontinued operations per share of common stock: Basic....................... $ (0.57) $ (0.05) $ (0.56) $ (0.09) Diluted..................... $ (0.56) $ (0.05) $ (0.55) $ (0.09) Net income per share of common stock: Basic....................... $ 0.42 $ 0.26 $ 0.72 $ 0.46 Diluted..................... $ 0.41 $ 0.25 $ 0.71 $ 0.45
See accompanying Notes to Condensed Consolidated Financial Statements. 3 R. R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES ------------ CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) JUNE 30, 1998 AND DECEMBER 31, 1997 (THOUSANDS OF DOLLARS) ASSETS
1998 1997 ---------- ---------- Cash and equivalents................................... $ 61,841 $ 47,814 Receivables, less allowance for doubtful accounts of $18,551 and $16,259 at June 30, 1998 and December 31, 1997, respectively.................................... 713,290 814,664 Inventories............................................ 189,295 201,402 Prepaid expenses....................................... 103,392 82,691 ---------- ---------- Total current assets................................. 1,067,818 1,146,571 ---------- ---------- Property, plant and equipment, at cost................. 4,283,167 4,214,765 Accumulated depreciation............................... 2,551,360 2,426,649 ---------- ---------- Net property, plant and equipment.................... 1,731,807 1,788,116 Goodwill and other intangibles--net.................... 375,290 385,512 Other noncurrent assets................................ 525,515 659,260 Net assets of discontinued operations.................. 46,542 154,707 ---------- ---------- Total assets......................................... $3,746,972 $4,134,166 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable....................................... $ 238,157 $ 291,666 Accrued compensation................................... 156,862 152,235 Short-term debt........................................ 45,000 45,000 Current and deferred income taxes...................... 137,981 58,888 Other accrued liabilities.............................. 248,755 264,833 ---------- ---------- Total current liabilities............................ 826,755 812,622 ---------- ---------- Long-term debt......................................... 957,674 1,153,226 Deferred income taxes.................................. 231,043 229,538 Other noncurrent liabilities........................... 353,097 347,283 Shareholders' equity: Common stock, at stated value ($1.25 par value)...... 320,962 320,962 Retained earnings, net of cumulative translation adjustments of $58,310 and $45,782 at June 30, 1998 and December 31, 1997, respectively................. 1,508,684 1,482,624 Unearned compensation................................ (7,922) (9,414) Reacquired common stock, at cost..................... (443,321) (202,675) ---------- ---------- Total shareholders' equity....................... 1,378,403 1,591,497 ---------- ---------- Total liabilities and shareholders' equity....... $3,746,972 $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 SIX MONTHS ENDED JUNE 30 (THOUSANDS OF DOLLARS)
1998 1997 --------- --------- Cash flows provided by (used for) operating activities: Net income............................................. $ 102,943 $ 67,017 Loss from discontinued operations...................... 80,067 13,019 Gain on sale of Metromail shares, net of tax........... (87,394) -- Depreciation........................................... 158,141 155,487 Amortization........................................... 18,450 21,156 Gain on sale of assets................................. (8,587) (12,048) Net change in operating working capital................ 24,245 165,647 Net change in other assets and liabilities............. 79,401 (30,134) Other.................................................. (13,179) (398) --------- --------- Net cash provided by operating activities................ 354,087 379,746 --------- --------- Cash flows provided by (used for) investing activities: Capital expenditures................................... (108,429) (226,213) Other investments...................................... (20,151) (35,471) Dispositions of assets................................. 16,023 28,782 Disposition of Metromail shares, net of tax............ 238,438 -- --------- --------- Net cash provided by (used for) investing activities..... 125,881 (232,902) --------- --------- Cash flows provided by (used for) financing activities: Net decrease in borrowings............................. (195,552) (96,782) Disposition of reacquired common stock................. 53,539 25,086 Acquisition of common stock............................ (294,085) (14,081) Cash dividends on common stock......................... (57,116) (56,603) --------- --------- Net cash used for financing activities................... (493,214) (142,380) --------- --------- Effect of exchange rate changes on cash and equivalents.. (825) 447 --------- --------- Net (decrease) increase in cash and equivalents from continuing operations................................... (14,071) 4,911 Net increase in cash from discontinued operations........ 28,098 20,561 Cash and equivalents at beginning of period.............. 47,814 21,317 --------- --------- Cash and equivalents at end of period.................... $ 61,841 $ 46,789 ========= =========
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 June 30, 1998, and Dec. 31, 1997, were as follows:
(THOUSANDS OF DOLLARS) ------------------ 1998 1997 -------- -------- Raw materials and manufacturing supplies.................... $119,193 $123,280 Work in process............................................. 164,730 153,142 Finished goods.............................................. 1,056 1,047 Progress billings........................................... (48,805) (31,715) LIFO reserve................................................ (46,879) (44,352) -------- -------- Total inventories....................................... $189,295 $201,402 ======== ======== Note 3. The following provides supplemental cash flow information: (THOUSANDS OF DOLLARS) ------------------ SIX MONTHS ENDED JUNE 30 ------------------ 1998 1997 -------- -------- Interest paid, net of capitalized interest................. $ 48,912 $ 44,546 Income taxes paid.......................................... $ 28,495 $ 31,168
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 six months ended June 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 $13 million and $5 million for the six months ended June 30, 1998 and 1997, respectively. Comprehensive income equaled $90 million and $62 million for the six months ended June 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 for $21 per share. 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 for its remaining interest in DESI. The accounting for the transaction will be reflected in the company's results for the quarter ending Sept. 30, 1998. 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 SECOND QUARTER AND FIRST HALF 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 generating 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 and educational 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 second quarter and first half of 1998 and 1997 are presented below: NET SALES BY BUSINESS UNIT
SECOND QUARTER ENDED JUNE 30, (THOUSANDS OF DOLLARS) 1998 % OF TOTAL 1997 % OF TOTAL ----------------------------- ---------- ---------- ---------- ---------- Merchandise Media............... $ 279,100 24% $ 289,540 25% Magazine Publishing Services.... 313,046 27% 310,017 27% Book Publishing Services........ 175,579 15% 182,116 16% Telecommunications.............. 175,519 15% 170,746 15% Financial Services.............. 146,235 13% 132,308 12% Other........................... 54,104 6% 52,048 5% ---------- ---- ---------- ---- $1,143,583 100% $1,136,775 100% ========== ==== ========== ====
9 NET SALES BY BUSINESS UNIT--YEAR TO DATE
FIRST HALF ENDED JUNE 30, % OF % OF (THOUSANDS OF DOLLARS) 1998 SALES 1997 SALES - ------------------------- ---------- ----- ---------- ----- Merchandise Media............................. $ 569,951 25% $ 575,651 26% Magazine Publishing Services.................. 644,047 28% 609,591 27% Book Publishing Services...................... 343,936 15% 353,165 16% Telecommunications............................ 365,532 16% 344,056 15% Financial Services............................ 269,786 12% 247,587 11% Other......................................... 111,727 4% 109,372 5% ---------- --- ---------- --- $2,304,979 100% $2,239,422 100% ========== === ========== ===
CONSOLIDATED RESULTS OF OPERATIONS The company reported income from continuing operations (excluding the gain on the sale of the company's remaining interest in Metromail) for the second quarter of 1998 of $51 million, or 36 cents per diluted share, compared with $45 million, or 30 cents per diluted share, in the second quarter of 1997. Including the Metromail gain and an $80 million impairment charge related to the write-down of the company's net assets of discontinued operations, net income for the second quarter was $59 million, or 41 cents per diluted share, compared with $38 million, or 25 cents per diluted share, in the second quarter of 1997. For the first six months of 1998, the company reported income from continuing operations (excluding the Metromail gain) of $96 million, or 66 cents per diluted share, compared with $80 million, or 54 cents per diluted share, in 1997's first half. Including the Metromail gain and the impairment charge, net income rose by 54 percent to $103 million, or 71 cents per diluted share, from $67 million or 45 cents per diluted share, a year earlier. CONSOLIDATED NET SALES Net sales for the second quarter of 1998 increased by $7 million to $1.1 billion. Magazine Publishing Services increased due to growth across most product categories and due to relatively strong demand. Telecommunications increased as a result of increased advertising demand. Financial Services increased due to the strength of the capital markets and the high level of mergers and acquisition activity. Book Publishing Services declined due to weakness in the four-color trade market and a reduction in distribution and fulfillment activities. Merchandise Media declined due to disappointing performance in retail inserts and changes in paper purchasing activities. Net sales for the first half increased by $66 million to $2.3 billion, due primarily to growth in Financial Services resulting from the strength of the capital markets and a significant customer's change in production cycle to move directory titles from the fourth quarter of 1997 to the first quarter of 1998. CONSOLIDATED EXPENSES Gross profit in the second quarter of 1998 increased 15% to $241 million and in the first half of 1998 increased 14% to $459 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 half, the company incurred higher expenses associated with the development of the company's logistics and fulfillment businesses and the start-up of a Roanoke, Va., book plant. 10 Selling and administrative expenses for the second quarter of 1998 increased 11% to $143 million, due to increases in information systems-related expenditures. The ratio of selling and administrative expenses to net sales was 13% for the second quarter of 1998 and 11% for the second quarter of 1997. Earnings from operations increased by 22% to $97 million, corresponding to an improvement in operating margins from 7% to 8.5% of net sales. Selling and administrative expenses in the first half of 1998 increased 9.5% to $274 million due to volume increases, increases in information systems- related expenditures and Stream International expenditures. The ratio of selling and administrative expenses to net sales was 11.9% for the first half of 1998 and 11.2% in the first half of 1997. Earnings from operations increased 21.8% to $185 million. The operating margin widened to 8% from 6.8% a year earlier. SUMMARY OF EXPENSE TRENDS
SECOND QUARTER ENDED JUNE 30, % INCREASE (THOUSANDS OF DOLLARS) 1998 1997 (DECREASE) ---------------------- --------- -------- ---------- --- --- --- Cost of materials....... $ 426,944 $441,761 (3.4%) Cost of manufacturing... 388,456 388,376 -- Depreciation............ 76,766 83,018 (7.5%) Amortization............ 10,669 14,783 (27.8%) Selling and administrative......... 143,429 129,154 11.1% Net interest expense.... 19,689 22,622 (13.0%) FIRST HALF ENDED JUNE 30, % INCREASE (THOUSANDS OF DOLLARS) 1998 1997 (DECREASE) ---------------------- --------- -------- ---------- Cost of materials....... $ 882,085 $868,602 1.6% Cost of manufacturing... 787,496 792,237 (0.6%) Depreciation............ 158,141 155,487 1.7% Amortization............ 18,450 21,156 (12.8%) Selling and administrative......... 273,649 249,932 9.5% Net interest expense.... 39,636 45,182 (12.3%)
NONOPERATING ITEMS Interest expense decreased approximately $3 million in the quarter and $6 million in the first half of 1998 due to lower average debt balances associated with improved balance sheet management. Other income declined approximately $8 million in the quarter due to a gain on the sale of investments in the second quarter of 1997 in the company's venture-capital portfolio. Other income declined approximately $12 million in the first half of 1998 due primarily to a non-recurring gain in 1997 on the sale of the company's interest in a magazine distribution venture in the United Kingdom and the gains in 1997 on the sale of investments in the company's venture- capital portfolio. 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 second quarter and first half of 1998 include an $80 million impairment charge related to the write-down of goodwill on the books of CS&T. Results for the second quarter and first half of 1997 include losses from discontinued operations of $7 million and $13 million, respectively. CHANGES IN FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES For the first half of 1998, net cash flow provided by operating activities was $354 million, down $26 million from last year's first half. Increased net income was offset by a decline in cash provided 11 from operating working capital (defined as inventories, accounts receivable and prepaid expenses, minus accounts payable, accrued compensation and other accrued liabilities) predominantly due to a smaller decline in receivables, larger decline in payables and the payment of incentive compensation. Capital expenditures totaled $108 million for the first half of 1998. Spending was directed principally to projects that are expected to further enhance productivity. Full-year capital spending is expected to total between $300 million and $350 million. Management believes that the company's cash flow and borrowing capacity are sufficient to fund current operations and growth. At June 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. SUBSEQUENT EVENT 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 for $21 per share. In conjunction with the merger agreement, the company committed to tender its shares in DESI pursuant to its offer. On July 7, 1998, the company received $45 million for its remaining interest in DESI. The accounting for the transaction will be reflected in the company's results for the quarter ending Sept. 30, 1998. 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 will include shares purchased for issuance under various stock option plans. The company utilized proceeds from the sale of its remaining interest in Metromail to support the $500 million share buyback. During the first half of the year, the company purchased approximately 7.1 million shares, at an average price of $41.83 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 a digital infrastructure 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, these efforts will be focused on ensuring that processes and systems are Year 2000 compliant. 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 is Year 2000 compliant. 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 systems such as building security and heating. 12 The company's efforts to address Year 2000 compliance issues include (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 has recently commenced evaluating 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. 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 it or important suppliers, vendors and external companies are not Year 2000 compliant in a timely manner. 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 believes that the cost of the Year 2000 initiative will not materially impact reported financial information so as not to be indicative of future operating results or financial condition. 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 13 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. 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. Although prices were slightly higher in the second quarter, 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. Most experts expect continued strength in the domestic economy; however, a significant change in the economic outlook could affect demand for the company's products, particularly in the financial printing market. 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. 14 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 1998 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 a cost that is not material 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 27 Financial Data Schedule
15 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) August 14, 1998 Date __________________________ 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 61,841 0 731,841 18,551 189,295 1,067,818 4,283,167 2,551,360 3,746,972 826,755 957,674 0 0 320,962 1,057,441 3,746,972 2,304,979 2,304,979 1,846,172 2,119,821 147,537 0 (39,636) 293,059 110,049 183,010 (80,067) 0 0 102,943 0.72 0.71
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