-----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, L0dm8PbEA87S5tGUdF/45v9Sm9GCaqUYZjYUx+knR2CqRV31y9U8IH/7X8RntPah IXI82YTz1EZws/1vEfAZug== 0000950131-99-003138.txt : 19990517 0000950131-99-003138.hdr.sgml : 19990517 ACCESSION NUMBER: 0000950131-99-003138 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 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: 99623733 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 March 31, 1999 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 March 31, 1999 130,805,876 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I FINANCIAL INFORMATION Item 1. Financial Statements
Page Index Number(s) ----- --------- Condensed Consolidated Statements of Income (Unaudited) for the three months ended March 31, 1999 and 1998..................... 3 Condensed Consolidated Balance Sheets as of March 31, 1999 (Unaudited) and December 31, 1998.............................. 4 Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 1999 and 1998................. 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 First Quarter 1999 to First Quarter 1998.......... 9 - 11 Changes in Financial Condition.................................. 12 Subsequent Events............................................... 12 Year 2000....................................................... 12 - 13 Other Information............................................... 13 - 15 Item 3. Quantitative and Qualitative Disclosures about Market Risk... 15 PART II OTHER INFORMATION Item 1. Legal Proceedings............................................ 16 Item 4. Submission of Matters to a Vote of Security Holders.......... 16 Item 5. Other Information............................................ 16 Item 6. Exhibits and Reports on Form 8-K............................. 16
2 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES ---------------- CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (Thousands of dollars, except share data)
Three Months Ended March 31 -------------------------- 1999 1998 ------------ ------------ Net sales.......................................... $ 1,179,816 $ 1,173,598 Cost of sales...................................... 936,880 955,539 ------------ ------------ Gross profit....................................... 242,936 218,059 Selling and administrative expenses................ 151,361 130,220 Income (loss) from operations of businesses held for sale.......................................... (2,959) -- ------------ ------------ Earnings from operations........................... 88,616 87,839 Other income (expense): Interest expense.................................. (19,896) (19,947) Other, net........................................ 2,792 117 ------------ ------------ Earnings before income taxes....................... 71,512 68,009 Provision for income taxes......................... 27,532 23,803 ------------ ------------ Net income......................................... $ 43,980 $ 44,206 ============ ============ Net income per share of common stock Basic............................................. $ 0.33 $ 0.31 Diluted........................................... $ 0.33 $ 0.30 Cash dividends per basic share..................... $ 0.21 $ 0.20 Average basic shares outstanding................... 132,777,000 143,928,000 Average diluted shares outstanding................. 134,359,000 146,220,000
See accompanying Notes to Condensed Consolidated Financial Statements. 3 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES ------------ CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) March 31, 1999 and December 31, 1998 (Thousands of dollars, except share data) ASSETS
1999 1998 ---------- ---------- Cash and equivalents................................... $ 74,998 $ 66,226 Receivables, less allowance for doubtful accounts of $15,112 in 1999 and $14,279 in 1998................... 799,531 843,094 Inventories............................................ 189,344 182,931 Prepaid expenses....................................... 112,350 63,040 ---------- ---------- Total current assets................................. 1,176,223 1,155,291 ---------- ---------- Property, plant and equipment, at cost................. 4,414,260 4,368,754 Accumulated depreciation............................... 2,731,757 2,667,827 ---------- ---------- Net property, plant and equipment.................... 1,682,503 1,700,927 Goodwill and other intangibles, net of accumulated amortization of $187,819 in 1999 and $183,589 in 1998. 389,947 381,394 Other noncurrent assets................................ 534,805 515,029 Net assets of businesses held for sale................. 42,517 45,476 ---------- ---------- Total assets......................................... $3,825,995 $3,798,117 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable....................................... $ 303,083 $ 331,257 Accrued compensation................................... 156,903 188,187 Short-term debt........................................ 60,000 60,000 Current and deferred income taxes...................... 18,937 2,263 Other accrued liabilities.............................. 294,100 242,251 ---------- ---------- Total current liabilities............................ 833,023 823,958 ---------- ---------- Long-term debt......................................... 1,165,428 998,978 Deferred income taxes.................................. 257,765 260,692 Other noncurrent liabilities........................... 415,944 413,611 Shareholders' equity: Common stock, at stated value ($1.25 par value) Authorized shares: 500,000,000; Issued 140,889,050 in 1999 and 140,889,050 in 1998.................... 308,462 308,462 Retained earnings.................................... 1,313,055 1,325,634 Cumulative translation adjustments................... (62,338) (55,050) Unearned compensation................................ (5,399) (6,118) Reacquired common stock, at cost..................... (399,945) (272,050) ---------- ---------- Total shareholders' equity....................... 1,153,835 1,300,878 ---------- ---------- Total liabilities and shareholders' equity....... $3,825,995 $3,798,117 ========== ==========
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 Three Months Ended March 31 (Thousands of dollars)
1999 1998 --------- --------- Cash flows provided by (used for) operating activities: Net income............................................. $ 43,980 $ 44,206 Loss from operations of businesses held for sale, net of tax................................................ 1,820 -- Depreciation........................................... 79,328 81,226 Amortization........................................... 12,234 11,045 (Gain) on sale of assets............................... (2,985) (1,176) Net change in operating working capital................ (43,771) (32,063) Net change in other assets and liabilities............. 18,459 650 Other.................................................. 1,862 (4,733) --------- --------- Net cash provided by operating activities................ 110,927 99,155 --------- --------- Cash flows provided by (used for) investing activities: Capital expenditures................................... (64,393) (54,432) Other investments including acquisitions, net of cash acquired.............................................. (52,465) (18,609) Dispositions of assets................................. -- 1,176 --------- --------- Net cash used for investing activities................... (116,858) (71,865) --------- --------- Cash flows provided by (used for) financing activities: Net increase in borrowings............................. 166,450 121,648 Issuances of common stock.............................. 1,464 17,539 Acquisition of common stock............................ (123,559) (150,732) Cash dividends on common stock......................... (28,017) (28,975) --------- --------- Net cash used for financing activities................... 16,338 (40,520) --------- --------- Effect of exchange rate changes on cash and equivalents.. (1,635) (259) Net increase in cash from businesses held for sale....... -- 22,595 --------- --------- Net change in cash and equivalents....................... 8,772 9,106 Cash and equivalents at beginning of period.............. 66,226 47,814 --------- --------- Cash and equivalents at end of period.................... $ 74,998 $ 56,920 ========= =========
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, 1998 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 1998 Annual Report on Form 10-K. The condensed consolidated financial statements included herein reflect, in the opinion of the company, all adjustments (which include only normal, recurring adjustments) necessary to present fairly the financial information for such periods. Certain prior year amounts have been reclassified to maintain comparability with current year classifications. Note 2. Components of the company's inventories at March 31, 1999, and December 31, 1998, were as follows:
(Thousands of Dollars) ------------------ 1999 1998 -------- -------- Raw materials and manufacturing supplies.................... $119,328 $121,490 Work in process............................................. 165,078 150,775 Finished goods.............................................. 913 1,220 Progress billings........................................... (46,078) (42,217) LIFO reserve................................................ (49,897) (48,337) -------- -------- Total inventories....................................... $189,344 $182,931 ======== ======== Note 3. The following provides supplemental cash flow information: (Thousands of Dollars) ------------------ Three Months Ended March 31 ------------------ 1999 1998 -------- -------- Interest paid.............................................. $ 5,693 $ 8,521 Income taxes paid.......................................... $ 10,508 $ 19,908
Note 4. On November 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Illinois, on behalf of all current and former African-American employees, alleging that the company racially discriminated against them in violation of the Civil Rights Act of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.). The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seek nationwide class certification, most of the specific factual assertions of the complaint relate to the closing by the company of its Chicago catalog operations in 1993. Other general claims relate to other company locations. On February 11, 1999, the magistrate judge ruled that all claims relating to the Chicago catalog operations were untimely. Plaintiffs have appealed this ruling. If the ruling of the magistrate judge is upheld, the claims relating to other locations will still be pending as is plaintiffs' motion for class certification. 6 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) On December 18, 1995, a class action was filed against the company in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. On August 14, 1997, the court certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations. On June 30, 1998, a purported class action was filed against the company in federal district court in Chicago on behalf of current and former African- American employees, alleging that the company racially discriminated against them in violation of Title VII of the Civil Rights Act of 1964 (Adams, et al. v. R.R. Donnelley & Sons Co.). While making many of the same general discrimination claims contained in the Jones complaint, the Adams plaintiffs are also claiming retaliation by the company for the filing of discrimination charges or otherwise complaining of race discrimination. The complaint seeks the same relief and damages as sought in the Jones case. Both the Jones and Gerlib cases relate primarily to the circumstances surrounding the closing of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations. Further, with regard to all three cases, the company believes it has a number of valid defenses to all of the claims made and will vigorously defend its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of any of the pending cases. In addition, the company is a party to certain litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the operations or financial condition of the company. Note 5. The company has adopted the Statement of Financial Accounting Standards No. 130, Comprehensive Income. 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, which 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 $5 million for the quarters ended March 31, 1999 and 1998, respectively. Comprehensive income equaled $37 million and $39 million for the quarters ended March 31, 1999 and 1998, respectively. Note 6. The company operates in the commercial printing industry. Substantially all revenues result from the sale of printed products and services to customers in the following markets: Book Publishing Services, Financial Services, Magazine Publishing Services, Merchandise Media and Telecommunications. The company's management has aggregated its commercial print businesses as one reportable segment due to strong similarities in the economic characteristics, nature of products and services, production processes, class of customer and distribution methods used. The company's investment in businesses held for sale has been disclosed as a separate reportable segment, as the revenues generated from these businesses are unrelated to the commercial printing industry--refer to "Businesses Held for Sale" for additional information. The company has disclosed earnings (loss) from operations as the primary measure of segment earnings (loss). This is the measure of profitability used by the company's chief operating decision-maker that is most consistent with the presentation of profitability reported within the consolidated financial statements. The accounting policies of the business segments reported are the same as those described in the "Summary of Significant Accounting Policies" (F-6 in the 1998 Annual Report on Form 10-K). 7 R.R. DONNELLEY & SONS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Industry Segment Information
Businesses Commercial Held for Consolidated In Thousands Print Sale Corporate Other(1) Adjustments(2) Total - ------------ ---------- ---------- --------- -------- -------------- ------------ First Quarter Ended March 31, 1999 Sales................... $1,121,189 $199,123 $ -- $58,627 $(199,123) $1,179,816 Earnings (loss) from operations............. 79,281 (2,959) 10,382 1,912 -- 88,616 Earnings (loss) before income taxes........... 174,248 (2,959) (101,339) 1,562 -- 71,512 Assets.................. 3,014,358 213,343 677,357 91,763 (170,826) 3,825,995 First Quarter Ended March 31, 1998 Sales................... $1,117,444 $175,773 $ -- $56,154 $(175,773) $1,173,598 Earnings (loss) from operations............. 79,894 -- 6,718 1,227 -- 87,839 Earnings (loss) before income taxes........... 160,470 -- (93,583) 1,122 -- 68,009 Assets.................. 3,229,360 295,109 624,100 98,978 (162,997) 4,084,550
- -------- (1) Represents other operating segments of the company. (2) Refer to discussion of "Businesses Held for Sale," which describes the separate presentation of the net assets and results of operations of businesses held for sale. Note 7. The company has used corporate-owned life insurance (COLI) to fund employee benefits for several years. In 1996, the United States Health Care Reform Act was passed, eliminating the deduction for interest from loans borrowed against COLI programs. 1998 was the final year of the phase-out period for deductions. Without the COLI deduction, the company anticipates a higher effective tax rate in 1999 and future years. The Internal Revenue Service (IRS), in its routine audit of the company, has disallowed the $34 million of tax benefit that resulted from the COLI interest deductions claimed by the company in its 1990 to 1992 tax returns. The company has challenged this position in a formal protest filed with the IRS Appeals division. The company expects to resolve the issue eventually in a manner that does not materially impact its financial position or results of operations. Note 8. On April 2, 1999, the company acquired certain net assets of the Communicolor division of The Standard Register Company (Communicolor). Communicolor, with locations in Newark, Ohio and Eudora, Kansas, is a provider of personalization services and printer of innovative direct-mail campaigns. The acquisition will be accounted for using the purchase method of accounting. On April 16, 1999, the company issued $200 million of 6 5/8% debentures due 2029. Proceeds received from the sale were used to reduce outstanding commercial paper borrowings incurred for working capital purposes and in connection with the financing of the company's acquisitions of Communicolor and the financial printing unit of Cadmus Communications, with the remainder to be used for general corporate purposes. 8 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations Comparison of First Quarter 1999 to First Quarter 1998 About the Company R.R. Donnelley & Sons Company is the largest commercial printer in North America. Our company is a leading provider of printing and related services to the merchandising, magazine, book, directory, financial and healthcare markets. We use our superior skills, scale and technology to deliver solutions that effectively meet our customers' needs. Our common stock (DNY: NYSE) has been publicly traded since 1956. At the end of March, 1999, we had approximately 32,000 employees working in our core printing operations on four continents. We also had 49 manufacturing plants with a broad range of capabilities to serve our customers. While 91% of our revenue is generated in the United States, we have extended our core competencies into selected international markets. Commercial printing in the United States is a large and fragmented industry, and includes more than 50,000 firms that employ more than one million people and generate approximately $150 billion in annual revenue. The segment of commercial printing that we serve generates approximately $80 billion in annual revenue. Within this segment, we have leadership positions in all five of our end markets: . Merchandise Media, serving the consumer and business-to-business catalog, retail insert and direct mail markets; . Magazine Publishing Services, serving the consumer, trade and specialty magazine markets; . Telecommunications, serving the global directory needs of telecommunications providers; . Book Publishing Services, serving the trade, children's, religious and educational book markets; and . Financial Services, serving the communication needs of the financial markets and healthcare industry. In addition to our U.S. operations, we operate in Mexico, South America, Europe and China. For reporting purposes, revenues from our international facilities primarily serving the directory market are reported within Telecommunications. Revenues from our two Mexico facilities that primarily serve the magazine market are reported within Magazine Publishing Services. Our third Mexico facility serves the book market and is reported within Book Publishing Services. Revenues from other international facilities serving more than one market are included in "Other." The "Other" classification also includes net sales from R.R. Donnelley Logistics Services (DLS), our logistics and distribution operation. DLS serves our print services customers and others by consolidating and sorting mail so that it is delivered to the postal system closer to the final destination, resulting in reduced postage costs and improved on-time delivery. Additionally, DLS delivers magazine newsstand, newspaper inserts and financial services products. Finally, revenue from Stream International Inc., which provides technical and help-line computer support to its customers, is included in "Other." While our printing plants are geographically diverse, the supporting technologies and knowledge base are shared. Our plants have a range of production capabilities to serve the five basic commercial print markets outlined earlier. We manufacture products for these markets with the operational goal of optimizing the efficiency of our common manufacturing platform. As a result, most plants produce work for customers in two or more of our end markets. 9 Sales results by business unit for the first quarter of 1999 and 1998 are presented below: Net Sales by Business Unit
First Quarter Ended March 31, (Thousands of Dollars) 1999 % of Total 1998 % of Total ----------------------------- ---------- ---------- ---------- ---------- Magazine Publishing Services.... $ 281,424 24% $ 291,678 25% Merchandise Media............... 274,754 23% 290,877 25% Telecommunications.............. 207,588 18% 190,013 16% Book Publishing Services........ 168,505 14% 165,815 14% Financial Services.............. 130,625 11% 123,551 10% Other........................... 116,920 10% 111,664 10% ---------- ---- ---------- ---- $1,179,816 100% $1,173,598 100% ========== ==== ========== ====
Consolidated Results of Operations For the first quarter of 1999, we reported net income of $44 million, or $0.33 per diluted share compared to net income of $44 million, or $0.30 per diluted share for the prior year. Gross profit for the first quarter rose 11% to $243 million, reflecting increased manufacturing productivity as discussed below, despite relatively flat sales between years. First quarter net income reflected a higher effective tax rate of 38.5% versus 35% for the prior year, due to the phase-out of deductions for the company's corporate-owned life insurance programs (COLI). Diluted earnings per share for the first quarter of 1999 also reflect the effect of the company's continued share repurchase program. Excluding the loss from operations of businesses held for sale, first quarter 1999 net income was $46 million, or $0.34 per diluted share. Consolidated Net Sales Net sales for the first quarter of 1999, including materials such as paper and ink, were flat compared to the prior year because of lower paper prices and fewer pass-through material sales. Lower paper prices and reduced paper sales impacted primarily Magazine and Merchandise Media. Telecommunications sales increased as a result of higher volumes, driven by page count increases from increased advertising demand. Financial Services sales increased due to the strength of our performance in the capital and healthcare markets despite lower commercial volumes. Financial Services sales also include the revenues from the acquisition of the financial printing unit of Cadmus Communications since March 1, 1999 ($4 million). Book Publishing sales also increased, reflecting higher volumes primarily for the one-color market. First quarter sales net of materials (primarily paper and ink) grew by 5% in 1999, reflecting the company's emphasis on higher value-added products and services. Consolidated Expenses Gross profit for the first quarter of 1999 increased 11% to $243 million, compared to $218 million a year ago. First quarter gross profit as a percentage of sales increased to 20.6% from 18.6% the prior year, driven primarily by continued improvements in manufacturing productivity. Selling and administrative expenses increased 16% to $151 million, or 12.8% of sales compared to 11.1% for the prior year. This increase reflected higher marketing-related expenses, increased selling costs from higher volumes, and additional expenditures related to Year 2000 remediation which did not occur in the first quarter of 1998. Earnings from operations for the first quarter increased slightly to $89 million, despite a loss from operations of businesses held for sale of $3 million as described in "Businesses Held for Sale." 10 Summary of Expense Trends
First Quarter Ended March 31, % Increase (Thousands of Dollars) 1999 1998 (Decrease) ---------------------- ---------- ---------- ---------- --- --- --- Cost of materials....... $ 429,014 $ 455,142 (5.7%) Cost of manufacturing... 416,304 408,126 2.0% Depreciation............ 79,328 81,226 (2.3%) Amortization............ 12,234 11,045 10.8% Selling and administrative......... 151,361 130,220 16.2% Net interest expense.... 19,896 19,947 (0.3%)
Nonoperating Items Interest expense for the first quarter was approximately $20 million in both 1999 and 1998. Lower commercial paper and medium-term note interest expense in 1999 was offset by higher interest expense on borrowings of foreign subsidiaries. Other income, net in 1999 reflects a gain of $3 million on the sale of real estate. Businesses Held for Sale During 1996, Stream International Holdings, Inc. (SIH), an 80%-owned equity investment of the company, reorganized into three independent businesses: Stream International, which provides outsource technical support services; Corporate Software & Technology (CS&T), a software distribution company; and Modus Media International (MMI), a global manufacturing and fulfillment business. CS&T and MMI comprised substantially all of the company's investment and net income in SIH. On December 15, 1997, SIH's businesses became separate companies and our ownership interest in SIH was restructured. We converted our equity and debt positions in Stream International into 87% of the common stock of that business. Additionally, we converted our equity and debt positions in CS&T into 86% of the common stock of CS&T and sold our equity and debt positions in MMI for non-voting preferred stock of MMI. The disposition of our interest in CS&T will be effected through the sale of the business, which is planned to occur during 1999. In connection with the planned disposition of CS&T, we have reported our interest in CS&T as businesses held for sale. During December 1998, the net assets and results of operations of businesses held for sale were reclassified from discontinued operations because the planned sale of CS&T did not occur in 1998, as originally intended. The net assets of CS&T are included in net assets of businesses held for sale as of March 31, 1999 and 1998. The non- voting preferred stock in MMI is included in other non-current assets as of March 31, 1999 and 1998. In the first quarter of 1999, we recorded a $3 million ($1.8 million after- tax) loss from operations of businesses held for sale related to CS&T. During 1998, we recorded an $80 million impairment charge (with no associated tax benefit) related to the write-down of goodwill on the books of CS&T. In 1997, we recorded a $100 million ($60 million after-tax) impairment charge to adjust the carrying costs of CS&T and MMI to their estimated net realizable values. Summary financial information of businesses held for sale has been disclosed within the "Industry Segment Information" (Note 6 of the Notes to Condensed Consolidated Financial Statements included in Part I of this Form 10-Q). 11 Changes in Financial Condition Liquidity and Capital Resources Net cash provided by operating activities in the first quarter of 1999 totaled $111 million, up $12 million from the same period in 1998. This was driven by an increase in income tax liabilities and increased accounts payable, partially offset by increased accounts receivable and higher accrued compensation payments. Capital expenditures totaled $64 million for the first quarter of 1999 compared to $54 million a year ago. Spending was directed principally to projects that further enhance productivity and to upgrade our systems infrastructure and capabilities companywide. Full-year capital spending is expected to exceed $300 million in 1999 in support of selected growth opportunities, including our expansion in Poland and a directory plant in Brazil. Management believes that the company's cash flow and borrowing capacity are sufficient to fund current operations and growth. On March 1, 1999, we purchased the financial printing unit of Cadmus Communications. The purchase includes the assets and operations of five service centers in Baltimore, Charlotte, Raleigh, Richmond and New York, as well as a print-on-demand and fulfillment facility in Charlotte and selected software products. At March 31, 1999, we had an unused revolving credit facility of $400 million with a number of banks. This credit facility provides support for the issuance of commercial paper and other credit needs. Subsequent Events On April 2, 1999, we acquired certain net assets of the Communicolor division of The Standard Register Company. Communicolor, with locations in Newark, Ohio and Eudora, Kansas, is a provider of personalization services and printer of innovative direct-mail campaigns. The acquisition will be accounted for using the purchase method of accounting. On April 16, 1999, we issued $200 million of 6 5/8% debentures due 2029. Proceeds received from the sale were used to reduce outstanding commercial paper borrowings incurred for working capital purposes and in connection with the financing of the company's acquisitions of Communicolor and the financial printing unit of Cadmus Communications, with the remainder to be used for general corporate purposes. Year 2000 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 continues to be necessary. In the near term, we are focusing these efforts 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. We have deferred 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 issue stems 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. 12 The company's efforts to address Year 2000 compliance issues in our core business include: . evaluating internal computing infrastructure, business applications and shop-floor systems for Year 2000 compliance, . replacing or renovating systems and applications as necessary to assure such compliance, and . testing the replaced or renovated systems and applications. Our efforts in these respects are well under way, and we continue to expect that substantially all phases of such efforts will be completed by mid-1999. In addition to our internal remediation activities, we have completed an initial evaluation of compliance by our key U.S. suppliers and vendors. We are continuing to evaluate other external companies, including customers whose systems interact with ours, and continue to expect to substantially complete this evaluation by mid-1999. Separate Year 2000 compliance programs are in progress at Stream International and CS&T. Although the company expects internal systems to be Year 2000 compliant as described above, we are implementing a process for development of contingency plans that will specify what we plan to do if critical systems, processes, suppliers, vendors and external companies encounter Year 2000 issues. The contingency planning effort focuses on those areas where our testing or evaluation does not demonstrate Year 2000 compliance, or where the criticality of the business process would make contingency planning prudent. Specific plans will be developed throughout the course of the year as these areas are identified. Company employees, assisted by the expertise of external consultants where necessary, staff the Year 2000 compliance efforts. Actual spending on our Year 2000 initiative in 1998 was $45 million, which is reflected in administrative expense. Management expects 1999 expenses to be similar. 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. Other Information Share repurchase--In September 1998, the board of directors authorized a program to repurchase up to $300 million of the company's common stock in privately negotiated or open-market transactions. The program includes shares purchased for issuance under various stock option plans. During the quarter, the company purchased approximately 3.6 million shares, at an average price of $36.14 per share. The program is expected to be completed by mid-1999. Technology--We remain a technology leader, investing not only in print- related technologies such as computer-to-plate, customer connectivity and digital imaging capabilities, but also in Internet-based business models, such as our SelectSource(R) and HouseNet(R) services. These businesses help our customers effectively deliver their content on the Internet. SelectSource and HouseNet address the online needs of catalogers and publishers, respectively. SelectSource offers content conversion and site development services for catalog and retail customers. HouseNet, an online community of interest focused on home improvement topics, aggregates content around the themes of home, garden, crafts and money management to offer a one- stop information resource for consumers. HouseNet was recently named Yahoo!'s number-one site for home improvement information for 1998. Book Publishing Services also applies technology to create solutions that enable our customers to manage and distribute content in multiple media formats. Our digital archiving and customer publishing solution allows education customers to build books online. In addition, Book Publishing Services is the leading supplier of conversion services to the emerging electronic book marketplace. 13 In the production process for print, increased digitization allows us to implement world-class manufacturing techniques. Digital workflows, coupled with on-press instrumentation and advanced statistical process control techniques, allow us to more effectively manage both our manufacturing assets and our raw material inputs. Additionally, new digital imaging capabilities are allowing higher levels of customization, enabling highly personalized printed products to be delivered to consumers. We are focused on investing in technologies that help us deliver products, services and solutions that are valued by our customers and thereby contribute to our financial performance. Litigation--On November 25, 1996, a purported class action was brought against the company in federal district court in Chicago, Illinois, on behalf of all current and former African-American employees, alleging that the company racially discriminated against them in violation of the Civil Rights Act of 1871, as amended, and the U.S. Constitution (Jones, et al. v. R.R. Donnelley & Sons Co.). The complaint seeks declaratory and injunctive relief, and asks for actual, compensatory, consequential and punitive damages in an amount not less than $500 million. Although plaintiffs seek nationwide class certification, most of the specific factual assertions of the complaint relate to the closing by the company of its Chicago catalog operations in 1993. Other general claims relate to other company locations. On February 11, 1999, the magistrate judge ruled that all claims relating to the Chicago catalog operations were untimely. Plaintiffs have appealed this ruling. If the ruling of the magistrate judge is upheld, the claims relating to other locations will still be pending as is plaintiffs' motion for class certification. On December 18, 1995, a class action was filed against the company in federal district court in Chicago alleging that older workers were discriminated against in selection for termination upon the closing of the Chicago catalog operations (Gerlib, et al. v. R.R. Donnelley & Sons Co.). The suit also alleges that the company violated the Employee Retirement Income Security Act (ERISA) in determining benefits payable to retiring or terminated employees. On August 14, 1997, the court certified classes in both the age discrimination and ERISA claims limited to former employees of the Chicago catalog operations. On June 30, 1998, a purported class action was filed against the company in federal district court in Chicago on behalf of current and former African- American employees, alleging that the company racially discriminated against them in violation of Title VII of the Civil Rights Act of 1964 (Adams, et al. v. R.R. Donnelley & Sons Co.). While making many of the same general discrimination claims contained in the Jones complaint, the Adams plaintiffs are also claiming retaliation by the company for the filing of discrimination charges or otherwise complaining of race discrimination. The complaint seeks the same relief and damages as sought in the Jones case. Both the Jones and Gerlib cases relate primarily to the circumstances surrounding the closing of the Chicago catalog operations. The company believes that it acted properly in the closing of the operations. Further, with regard to all three cases, the company believes it has a number of valid defenses to all of the claims made and will vigorously defend its actions. However, management is unable to make a meaningful estimate of any loss that could result from an unfavorable outcome of any of the pending cases. In addition, the company is a party to certain litigation arising in the ordinary course of business which, in the opinion of management, will not have a material adverse effect on the operations or financial condition of the company. 14 Environmental Regulations--Our business is subject to various laws and regulations relating to employee health and safety and to environmental protection. Our policy is to comply with all laws and regulations that govern protection of the environment and employee health and safety. We do not anticipate that compliance will have a material adverse effect on our competitive or consolidated financial positions. Outlook--The commercial printing industry in the United States (our primary geographic market) is highly competitive in most product categories and geographic regions. Competition is largely based on price, quality and servicing the special needs of customers. Industry analysts believe that there is overcapacity in most commercial printing markets. Therefore, competition is fierce. We are a large user of paper, bought by us or supplied to us by our customers. The cost and supply of certain paper grades used in the manufacturing process will continue to affect our financial results, primarily at the revenue line. However, management currently does not see any disruptive conditions affecting prices and supply of paper in 1999. Postal costs are a significant component of our customers' cost structure. Changes in postal rates, which became effective in January 1999, are not expected to negatively affect the company. In fact, postal rate increases enhance the value of R.R. Donnelley Logistic Services to our customers, as we are able to improve the cost and efficiency of mail processing and distribution. This ability to deliver mail on a more precise schedule and at a lower cost enhances our position in the marketplace. In addition to paper and postage costs, consumer confidence and economic growth are key drivers of print demand. While current economic conditions remain favorable, there is uncertainty around the future business environment. A significant change in the economic outlook could affect demand for the company's products, particularly in the financial printing market. In the longer term, technological changes, including the electronic distribution of information, present both risks and opportunities for the company. We believe that with our competitive strengths, including our comprehensive service offerings, technology leadership, depth of management experience, customer relationships and economies of scale, we can develop the most valuable solutions for our customers, which should result in sustained growth in shareholder value. Item 3 Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risk from changes in interest rates and foreign exchange rates. However, we generally maintain more than half of our debt at fixed rates (approximately 62% at March 31, 1999), and therefore our exposure to short-term interest rate fluctuations is immaterial to the consolidated financial statements as a whole. Our exposure to adverse changes in foreign exchange rates also is immaterial to our consolidated financial statements as a whole, and we occasionally use financial instruments to hedge exposures to foreign exchange rate changes. We do not use financial instruments for trading purposes and are not a party to any leveraged derivatives. Further disclosure relating to financial instruments is included in the Debt Financing and Interest Expense note in the Notes to Consolidated Financial Statements included in our 1998 Annual Report on Form 10-K. 15 PART II OTHER INFORMATION Item 1. Legal Proceedings On each of November 25, 1996, and June 30, 1998, purported class actions were brought against the company alleging racial discrimination and seeking actual, compensatory, consequential and punitive damages in an amount not less than $500 million. On December 18, 1995, a class action was brought against the company alleging age discrimination in connection with the 1993 closing of the company's Chicago catalog operations, and violation of the Employee Retirement Income Security Act. These actions are described in part I of this quarterly report on Form 10-Q. Item 4. Submission of Matters to a Vote of Security Holders (a) The company held its Annual Meeting of Stockholders on March 25, 1999. (b) The following matters were voted upon at the Annual Meeting of Stockholders: 1. The election of the nominees for Directors of Class 2, who will serve for a term to expire at the Annual Meeting of Stockholders to be held in 2002, was voted on by the stockholders. The nominees, all of whom were elected, were Joseph B. Anderson, Jr., Judith H. Hamilton and Bide L. Thomas. The Inspectors of Election certified the following vote tabulations:
For Withheld ----------- --------- Joseph B. Anderson, Jr.............................. 116,969,991 1,523,554 Judith H. Hamilton.................................. 117,614,177 879,368 Bide L. Thomas...................................... 117,571,873 921,672
2. A stockholder proposal regarding pay equity was rejected by the stockholders. The Inspectors of Election certified the following vote tabulations:
For % Against % Abstain % Non-Vote % ---------- --- ---------- --- --------- --- --------- --- 18,339,202 15% 92,019,201 78% 2,603,423 2% 5,531,719 5%
3. A stockholder proposal regarding global corporate standards was rejected by the stockholders. The Inspectors of Election certified the following vote tabulations:
For % Against % Abstain % Non-Vote % --------- --- ----------- --- --------- --- --------- --- 3,640,553 3% 103,809,782 87% 5,511,491 5% 5,531,719 5%
Item 5. Other Information Certain statements in this filing, including the discussions of management expectations for 1999, 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 1998 Annual Report on Form 10-K for a description of such factors. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 27 Financial Data Schedule
(b) No current report on Form 8-K was filed during the first quarter of 1999. 16 SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. R.R. Donnelley & Sons Company /s/ Gregory A. Stoklosa By __________________________________ Corporate Controller (Authorized Officer and Chief Accounting Officer) May 14, 1999 Date __________________________ 17 EX-27 2 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from R.R. Donnelley and Sons Company and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 74,998 0 814,643 15,112 189,344 1,176,223 4,414,260 2,731,757 3,825,995 833,023 1,165,428 0 0 308,462 845,373 3,825,995 1,179,816 1,179,816 936,880 1,086,616 167 1,625 19,896 71,512 27,532 0 0 0 0 43,980 .33 .33
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