RRD.WI Donnelley (R.R.) & Sons Co.

R.R. Donnelley & Sons Co. (RRD) reported earnings per share (EPS) of 53 cents in the second quarter of 2011, which made it past the Zacks Consensus Estimate by 2 cents.

Operating Performance

EPS on a non-GAAP basis increased 12.8% on a year-over-year basis and excludes restructuring and impairment charges and acquisition expenses.

Net income came in at $105.6 million, up from $99.5 million in the prior-year quarter. Net income margin declined 11 basis points (bps) to 4.02% in the quarter.

Gross margin remained flat year over year at 24.5% in the quarter, as productivity efforts, the acquisition of Bowne, lower variable compensation expense and a higher recovery on print-related by-products were offset by lower volume, primarily in books and directories, and pricing pressure.

As a percentage of total revenue, selling general & administrative (SG&A) expense was 11.8% in the reported quarter versus 11.1% in the year-ago quarter, primarily due to the acquisition of Bowne, and higher pension and other benefits related expenses.

Operating income on a non-GAAP basis was up 1.8% year over year to $192.7 million in the quarter. Operating margin decreased to 7.3% from 7.9% reported in the year-ago period. Changes in foreign exchange rates, due to export sales from certain international operations, and higher pass-through paper sales negatively impacted the non-GAAP operating margin by approximately 29 basis points.

Segment wise, U.S. Print and Related Services operating margin was 10.3% compared with 10.1% reported in the year-earlier quarter. The yearly gain in the segment’s operating margin was attributable to productivity initiatives, lower variable compensation expense and a higher recovery on print-related by-products, which offset the impact of volume declines and continued pricing pressure.

International operating margin was 7.6% in the quarter versus 8.2% in the year-ago quarter. The decline was on account of changes in foreign exchange rate; primarily due to export sales from certain operations, as well as pricing pressure more than offset the benefits of increased volume and productivity efforts.

Revenue

Revenues increased 8.9% year over year to $2.62 billion, but missed the Zacks Consensus Estimate of $2.69 billion.

Net revenue comprise U.S. Print and Related Services revenue (73.2% of total sales), which increased 6.2% year over year to $1.92 billion. The increase was primarily due to the acquisition of Bowne and volume increases in commercial, logistics and financial print, partially offset by volume declines in books and directories and continued pricing pressure across the segment.

International sales (26.8% of total sales) increased 17.2% to $702.5 million. The year- over-year growth was driven by increased sales related to the acquisition of Bowne.

Balance Sheet

R.R. Donnelley exited the quarter with $363.0 million of cash versus $399.3 million in the previous quarter. Long-term debt was $3.43 billion at quarter end compared with $3.24 billion at the end of the previous quarter.

Recommendation

Management did not provide any guidance. The Zacks Consensus Estimate projects an EPS of 56 cents for the third quarter of 2011.

Donnelley is witnessing stabilization in demand, increase in volumes and new customer wins. We believe that strong alliances and customer wins including AT&T Inc. (T) and Verizon Communications Inc. (VZ) will create value for the company over the long term. We also remain positive about the Journalism Online LLC acquisition.

However, higher pension expenses, continuing pricing pressure and a highly leveraged balance sheet are expected to create significant headwinds going forward.

We maintain our Neutral rating on a long-term basis (6-12 months). Currently, R.R. Donnelley has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).

 
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