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

R.R. Donnelley & Sons Co. (RRD) reported non-GAAP earnings per share (EPS) of 51 cents in the third quarter 2011, which was in line with the Zacks Consensus Estimate. The reported EPS was up 16.0% from the previous-year quarter and excludes restructuring and impairment charges and acquisition expenses.

Operating Performance

Gross Profit increased 6.4% from the prior-year quarter to $627.0 million. Gross margin slipped marginally to 23.4% compared with 23.7% in the year-ago quarter due to pricing pressure, which was however mostly offset by productivity improvements, a higher recovery on print-related by-products and lower variable compensation expense.

As a percentage of total revenue, selling general & administrative (SG&A) expense was 11.1% in the reported quarter versus 10.5% in the year-ago quarter. The increase was primarily due to the acquisition of Bowne, and higher pension and other benefits related expenses, which were partially offset by lower variable compensation expense.

Operating income on a non-GAAP basis was down 4.2% year over year to $191.7 million in the quarter. Operating margin decreased to 7.1% from 8.0% reported in the year-ago period. Margins were negatively impacted by pricing pressures that more than offset the productivity improvements, lower variable compensation expense and a higher recovery on print-related by-products.

U.S. Print and Related Services non-GAAP operating margin was 10.0%, which was flat compared with the previous-year quarter. Margins were impacted by productivity improvements, lower variable compensation expense, a higher recovery on print-related by-products and volume increases in logistics and commercial print, which were offset by the volume declines in books and directories and continued pricing pressure across the segment.

International operating margin on-GAAP operating margin declined to 5.9% from 8.5% in the prior-year quarter due to pricing pressure coupled with an unfavorable impact from changes in foreign exchange rates, as well as wage and other inflation in certain countries. However, these factors were only partially offset by lower variable compensation expense.

Revenue

Revenues on reported basis increased 7.8% year over year to $2.68 billion, but missed the Zacks Consensus Estimate of $2.69 billion by a whisker.

Segment wise, revenue from Product, which comprises around 88.1% of the revenues, increased 6.8% from the previous-year quarter to $2.36 billion. Services, which comprises 11.9% of the revenues, increased 16.1% from the prior-year quarter to $318.4 million.

U.S.print and related services revenue was up 6.3% from the previous-year quarter to $2.0 billion, primarily led by the acquisition of Bowne and volume increases in commercial print and logistics, which was partially offset by volume declines in books and directories and continued pricing pressure across the segment. Including the adjustments made for the acquisitions, net sales in the segment decreased 0.4%.

International sales increased 12.3% from the previous-year quarter to $703.9 million, including increased sales due to the acquisition of Bowne. Including the adjustments made for the acquisitions, net sales increased by $49.2 million up 7.5%, as changes in foreign exchange rates and increased volume more than offset the impact of continued pricing pressure.

Balance Sheet

R.R. Donnelley exited the quarter with $368.1 million of cash versus $363.0 million in the previous quarter. Long-term debt was $3.42 billion at quarter end, compared with $3.43 billion at the end of the previous quarter.

Recommendation

We remain Neutral on R.R. Donnelley on a long term basis (3-6 months). R.R. Donnelley is witnessing stabilization in demand, a higher recovery on print-related by-products and volume increases in logistics and commercial print and new customer wins. We believe that strong alliances and customer wins including those of AT&T Inc. (T) and Verizon Communications Inc. (VZ) will create value for the company over the long term.

However, we prefer to remain on the sidelines due to weak macro-economic conditions prevailing in most of Donnelley’s current and prospective markets. Moreover, higher pension expenses, continuing pricing pressure, volatility in raw material prices and a highly leveraged balance sheet are significant headwinds going forward.

Currently, R.R. Donnelley has a Zacks #4 Rank, which implies a Sell rating on a short-term basis (1-3 months).

 
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