R.R. Donnelley & Sons Company Q3 2008 Earnings Call Transcript

| About: R.R. Donnelley (RRD)

R.R. Donnelley & Sons Company (NASDAQ:RRD)

Q3 2008 Earnings Call

November 5, 2008 10:00 a.m. ET

Executives

Thomas J. Quinlan III – Chief Executive Officer and President

Miles W. McHugh – Chief Financial Officer and Executive Vice President

Andrew B. Coxhead – Senior Vice President, Controller and Chief Accounting Officer

Dan Leib – Senior Vice President, Treasurer

Analysts

Edward Atorino – Benchmark Company

Atin Agrawal – Longbow Capital

Craig Huber – Barclays Capital

Charles Strauzer – CJS Securities

Matthew Troy – Citigroup

Piyush Sharma – Longbow Research

Karl Choi – Merrill Lynch & Co.

Jake Kemeny – Morgan Stanley

Operator

My name is Sierra and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2008 financial results conference call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Dan Leib. Sir, you may begin your conference.

Dan Leib

Thank you, Sierra. Good morning and thank you for joining for us for R.R. Donnelley’s third quarter 2008 earnings conference call. Earlier this morning we released our earnings report. A copy of which can be found in the investor’s section of our website at rrdonnelley.com.

During this call, we will refer to forward-looking statements that are subject to uncertainty. For a complete discussion please refer to the cautionary statement included in our earnings release and further detailed in our annual report on form 10-K and other filings with the SEC. Further, we will discuss non-GAAP and Pro Forma financial information. We believe the presentation of non-GAAP and Pro Forma financial results provide you with useful supplementary information concerning the company’s ongoing operations and are an appropriate way for you to evaluate the company’s performance.

They are, however, provided for informational purposes only. Please refer to the press release and related footnotes for GAAP information and a reconciliation of GAAP to non-GAAP information. We’ve also posted to our website in the investor presentation section a description, as well as reconciliations of non-GAAP measures to which we will refer on this call.

We are joined this morning by Tom Quinlan, Miles McHugh and Drew Coxhead. I will now turn the call over to Tom.

Thomas J. Quinlan III

Thank you, Dan. Good morning everyone and thank you for joining us this morning. We’ll begin by having Miles take you through the quarter in detail. Then I will share some very brief comments and we will open it up for questions. Miles.

Miles W. McHugh

Thank you, Tom. I’ll provide a detailed review of third quarter results as well as talk about our expectations for full year 2008. Given the status of the economy, we are relatively pleased with our third quarter performance as we generated strong cash flow and earnings.

Non-GAAP earnings per diluted share increase 7.4% to $0.87 in the third quarter of this year compared to last year’s third quarter non-GAAP earnings per diluted share of $0.81. As is more important than ever in these difficult economic times, our strong balance sheet, substantial liquidity and consistent healthy cash flow allowed us to continue to serve our customers and invest in our business.

The integration of our most recent acquisitions has proceeded well. Third quarter consolidated non-GAAP operating margin of 11.5% represents a 71 basis point increase from third quarter 2007 reported results. Driving this improvement, was the reversal in the third quarter of variable compensation expense previously accrued in the first half resulting in a significant reduction in variable incentive compensation expense and accounted for nearly 280 basis points of the change as well as focused productivity initiatives that mitigated the negative impacts within the quarter of the global economic slowdown.

The acquisitions of Proline and Cardinal brands both of which had historically lower margins than our base business reduced operating margins by 26 basis points. And changes in foreign exchange rates decreased operating margins by 23 basis points in the quarter. Consolidated net sales in the third quarter were $2.9 billion down 1.6% from third quarter 2007 results.

On a Pro Forma basis, adjusting for the impact of acquired companies; net sales declined 4.0% from the third quarter of 2007. Volume declines and continued price pressures were partially offset by the acquisitions and favorable foreign exchange rates. As foreign exchange comparisons contributed 88 basis points to third quarter growth. Changes in paper prices did not significantly impact our revenue.

Our gross margin was 27.0% in the third quarter of this year compared to 27.1% in the third quarter of 2007. This decrease of approximately 4 basis points was due to the benefits of our continuing productivity and cost management efforts and the variable compensation expense reduction offset by volume and mixed declines, continued price pressures, unfavorable foreign exchange impacts and the inclusion of acquired businesses with historically lower margins.

Our SG&A as a percentage of revenue decreased 125 basis points to 9.8% in the third quarter from 11.0% in the third quarter of the prior year primarily due to the variable compensation expense reduction. Depreciation and amortization expense in the third quarter was $164.7 million, an increase of $11.9 million over the $152.8 million reported during the comparable period a year ago.

GAAP operating income including restructuring and impairment charges was $306.4 million in the third quarter of 2008 compared to $294.4 million in the third quarter the prior year. Excluding restructuring and impairment charges, non-GAAP operating margins increased 71 basis points from the third quarter of 2007 to 11.5%. Undoubtedly, these are tough economic times. Our scale and breath of products and services as well as continued management and financial discipline have positioned us well to perform through this downturn. We continue to drive productivity benefits through the business.

Net interest expense was $56.2 million in the quarter versus $59.1 million in the comparable quarter of the prior year primarily due to lower short-term borrowing rates and higher interest income from cash invested internationally. The GAAP effective tax rate in Q3 2008 increased to 32.0% from 25.1% in the third quarter of 2007 primarily due to the favorable impact on the 2007 tax rate of the lowering statutory tax rate in the United Kingdom that generated a $9.3 million reduction in the net deferred tax liabilities, a larger proportion of taxable income being generated in higher tax jurisdictions and a higher tax rate on foreign earnings in 2008 that was partially offset by the benefit in the current quarter from a resolution of uncertain tax positions.

On a non-GAAP, the tax rate increased by 240 basis points to 32.3% in the third quarter of 2008 from last year’s third quarter. As I mentioned, our non-GAAP earnings per share from continuing operations in the third quarter of 2008 increased 7.4% to $0.87 per diluted share compared to the third quarter of 2007.

Now let’s turn to third quarter operating results by segment. Sales for our U.S. print and related services segment declined 0.8% to $2.1 billion for the quarter. Pro Forma sales decreased 4.2% as volume declines across most product lines resulting from the recessionary environment and continuing price pressures more than offset sales increases in logistics services and forms and labels.

Sales of logistics services increased due to higher fuel surcharges related to higher fuel costs combined with higher co-mailing volume partially offset by lower print distribution volume. Sales and forms and labels grew due to new customer engagements partly offset by lower volumes generated from our existing customers.

Non-GAAP operating margins increased by 86 basis points to 14.2% in the third quarter of 2008. On a like for like basis including the acquisitions in both periods, operating margins increased approximately 129 basis points from the third quarter of 2007 to the third quarter of 2008. This increase was driven by the variable compensation expense reduction and our aggressive productivity and cost take out efforts offset in part by the effects of the economic slowdown as it related to volume, price and cost inflation.

Our international segments reported sales dropped 3.6% to $721.2 million due to volume declines in business process outsourcing services, European print, and financial print combined with overall price pressures partially offset by the favorable impact of foreign exchange rate changes and volume increases in our print services in Asia and Latin America.

Non-GAAP operating margins increased 147 basis points to 9.1% in the third quarter of 2008 due to our productivity and cost take out initiatives and the variable compensation expense reduction that offset volume declines, price pressures and unfavorable foreign exchange rate changes. While acquisitions had no impact on international results, foreign exchange rate changes added 341 basis points of top line growth yet resulted in nearly 80 basis points of decline in the non-GAAP operating margin.

Finally, excluding restructuring and impairment charges, our unallocated corporate expenses increased $8.9 million from last year’s third quarter due to increases in both LIFO inventory and bad debt provisions which were partially offset by the variable compensation expense reduction. During the third quarter of 2008, we spent $81.2 million on capital expenditures bringing our total year-to-date CapEx to $238.7 million.

We expect full year capital expenditures to be approximately $365 million. A significant decrease from last year’s $482 million and slightly less than we projected last quarter as we leveraged the capacity that our acquisitions have provided, continue to realize the benefits associated with optimizing our platform and more tightly control new capital spending in these challenging economic times.

We generated almost $700 million in cash from operations on a year-to-date basis. In the third quarter, cash generated from operations declined $28 million over the last year’s third quarter primarily as a result of lower volume. The reduction in incentive compensation expense that benefited earnings in the quarter did not impact the current quarter’s cash flow but will increase cash flows in the first quarter of 2009 compared to the first quarter of 2008.

Our balance sheet and liquidity continue to be very strong. Our debt is approximately 82% fixed at an average cost of 5.5% on our fixed rate debt. Our $2 billion committed revolver which is a backstop to the CP program and can be used for general corporate purposes matures in January 2012. By accessing both the revolver and the CP market, we experienced no interruptions in short-term funding during the most volatile times in the third quarter.

We continue to maintain investment grade credit metrics. Net debt at the end of the third quarter was $3.9 billion. We have sufficient liquidity in the form of cash flow from future operations, cash on hand and short-term debt availability to repay our next long-term maturity of $400 million in April 2009 even if the credit market restrictions remain well into next year.

We entered 2008 in a very favorable position related to our defined benefit pension plans with an aggregate overfunded status of $682 million. By year end 2008, we will have contributed $36 million to a variety of different pension plans and will have recognized pension income of $17 million in our income statement. We do a pension valuation as of December 31 of each year.

While next year’s pension income and funding cannot yet be determined there will be a few factors that will drive the asset valuation, cash contribution level and income statement impact next year and in the future. These factors are actual asset valuations, expected future rates of return and the assumed discount rates on our pension liabilities. While our aggregate year end pension over funding will likely decline, we still expect to remain over funded into 2009.

We have revised our non-GAAP EPS guidance from continuing operations for the full year 2008 to be in the range of $3.08 to $3.11 per diluted share. As we all know, the recent confluence of economic, credit and currency difficulties worldwide has made forecasting future customer demand and other business trends more uncertain than ever before. So this guidance for the fourth quarter does not take into consideration customer specific or broader economic changes that no one, including us, can foresee at this time.

We are assuming revenue trends in the fourth quarter that mirror those experienced in the third quarter. We would expect our non-GAAP operating margin to be at or slightly better than 10% we delivered last. As we expect productivity initiatives and reduction in variable incentive compensation to outweigh the impact of combined volume declines and price pressures.

We expect $650 million of depreciation and amortization inclusive of approximately $130 million in estimated purchase accounting amortization. We expect net interest expense of approximately $230 million during the year and a non-GAAP effective tax rate of between 32.5% and 33.5%.

Through the combination of earnings growth and disciplined capital spending, we continue to expect EBITDA less CapEx to grow by greater than 15% in 2008 compared to last year. And with that I’ll return you to Tom.

Thomas J. Quinlan III

Thank you, Miles. There are very few people, if any, alive today who have experienced in their professional careers the kind of volatility that is taking place in the economy today. Even those who work through the dot com bubble, the recession in the early 90s, the energy crisis of 1979 or the OPEC troubles from the early 70s, have not seen a global economic environment like this one.

You have read and heard ad nauseum about all of the factors that are battering the economy and about how these were compounded by structured products and regulatory changes. I am not going to address that. I am going to say that we know there is no magic formula, no silver bullet, and no single catalyst that is going to get the global economy or even the U.S. economy immediately heading in a direction we would all like to see.

While I cannot sit here today and tell you how long this decline will last, I can tell you what I believe will characterize the companies that are going to fight through and survive this unprecedented period. These will be the companies whose cornerstone strings are prized by all stakeholders. What are these cornerstones? We believe that there are five: world class customers, rep and diversity of the operating platform, scale, technology, balance sheet. These are the cornerstones that exist at R.R. Donnelley.

They provide the foundation that will allow us even during this challenging time to put our valued customers first. We will continue to deliver first class service to assist our customers as they seek to mitigate cost and to help them maximize their return on the investments that they make in the pre-media, printing, logistics, outsourcing, and other services we provide.

It has been and it is still about the customers. We believe that our cornerstones range differentiate R.R. Donnelley from all others in our industry. No one else has the product offering, the scale, the technology leadership, and the flexibility afforded by a strong balance sheet. No one else can present as compelling an offer for the best opportunities with the strongest customers.

Before we open it up for questions, I want to say something about our employees. This past quarter, we had to deal with more than just economic turbulence. It is easy to forget the typhoons, hurricanes, and other storms that hit our locations across the world. For example, during the last quarter, hurricanes came ashore and reached all the way into the Ohio valley. A number of our facilities were hit by these storms that knocked out power and disrupted communities often for several days.

Even if they had to hand address shipments by flashlight, our people found a way to take care of customers and assure not just business continuity but business distinction. Thank you. We also told you we regard safety as the first measure of operational excellence. For the first three quarters, our safety metrics are outperforming the industry average by 45%.

Our people are the best in the business and I am confident that they will continue to respond to the present economic challenge. R.R. Donnelley is a company that is more diversified, more agile, and better equipped than ever before to battle through these unprecedented times.

Operator, let's open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Edward Atorino with Benchmark.

Edward Atorino - Benchmark Company

I am almost never first. Thank you. Could you talk about the volume trends in some of the traditional areas, magazines, books, catalogs, inserts, financial print, et cetera?

Thomas J. Quinlan III

Sure, Ed, I can. I am sorry, go ahead.

Edward Atorino - Benchmark Company

No, it's kind of I realized, sometimes you do not want to be specific but if you could sort of put some dimension on the type of declines you are experiencing?

Thomas J. Quinlan III

Sure. And as the long saying goes, the last shall be first. Good morning, Ed, and I want to let you know, obviously, this quarter was one where every single industry vertical in the world was impacted by with their top line. We need to look at it and hopefully, in an easy way for everybody to understand, GDP is obviously what we feel as a sort of metric that can be used to see where we're headed, how things are working and if you look at what we call the four building blocks there, you have got advertising which is obviously very dependent upon how consumers spend where we participate with magazines, commercial print product, and directories.

You have got brand which again that is marketing brand recognition retaining customers getting new ones, the direct mail part of what we have got going on. You have got the business model which, for us, we looked at not only books but catalogs and obviously, books with some of the state deficits, state balancing issues that they have had in the middle of the quarter impacted us but at the same time, our customers that we had have to end up pulling their product at some point in time.

Catalogs, the same thing, we have got some real live examples of people who, during the quarter specifically, pulled some catalogs because they did not want them to incur the cost and the drop-off that they saw in their top line was directly impacted by the fact that the catalogue was not out there.

When you go down to compliance, obviously, statement printing plays a role there, the mutual funds and prospectives; those items are going to continue to occur in the economy. So, I think as you think about trends, we look to see where will the consumer be and those trends are going to drive how our business is going to end up before. We obviously know that we have got a match cost to revenues and we have done that for years and that is not going to change.

The headwinds that are out there that are against us from a top line standpoint though also opened up some opportunities for us with customers. We can bring savings to customers and that is the biggest distinction that we have got going for us right now. We can get out there and by leveraging our scale, leveraging our buying power, taking advantage of our technology whether it is intelligent bar coding, whether it is co-mail and co-palletization, we can lower your logistic cost and when the Q comes out to see that logistics had a pretty good quarter for us.

Those are the things where at this particular time our customers are looking for somewhat and particularly us to come through and figure out how we can mitigate their cost first while at the same time reaching their customers so that they can then continue to grow their business. Having the customers that we have got have never been important as it is now and we have got roughly 40,000 of them that are out there that we think we can bring this platform to bear for them.

Edward Atorino - Benchmark Company

Those two other questions, the trends, I guess, trends that are worsened as the quarter moves along into the fourth quarter, and second, on the SG&A which was a great job there, can you continue to bring that down into 2009 or there is some sort of base here that it pumped against?

Thomas J. Quinlan III

No, again, I think this industry where we know there has been pricing pressure since the start of it. So, that is something that we completely understand and there are always opportunities to take out cost. I mean, understand how we built this platform in a variable compensation. It is a good one to point towards. Our interests have always been aligned with our stakeholders, shareholders, bondholders, employers, vendors, you name it, we have always tried to align ourselves then and we have managed our capital with that as one of the drivers for us.

The fact that we are not going to be able to achieve the targets that we set out this year, at the level we thought, it is evident in what we have done today on variable compensation. If we are able to get there completely, then obviously, we would not have that. But we have made that a variable cost. There is still the scale that we have formed our procurement standpoint. There is technology again that I talked about with our new integrated printing system, three line that is out there that again, is good for us from a cost standpoint, also good for our customers because we can go ahead and lower their cost from that standpoint.

Miles W. McHugh

And that I can add to that a good portion of the CapEx that we invest every year as well as our corporate cost is related to information technology spending that throughout the platform on the operations and side of it continues to provide us opportunities to drive down SG&A and overall cost. So, there is still more opportunities there. We expect there continued to be opportunities going forward as well as the recent acquisitions and some of the past ones still provide us more opportunity to drive out cost through the business as we make those information technology investments.

Edward Atorino - Benchmark Company

That's great. Thanks.

Thomas J. Quinlan III

Thank you, Ed.

Operator

Your next question comes from the line of Atin Agrawal with Longbow Capital.

Thomas J. Quinlan III

Good morning.

Atin Agrawal - Longbow Capital

Tom, you mentioned that in this environment, your customers are looking at opportunities to reduce their cost, so, are you seeing any uptake in the print management outsourcing deals?

Thomas J. Quinlan III

Yes, we are and again, I think as much as we would like to believe over the last, it is not as if we just started it this year, we have been at it for a while, but you get people's attentions at a time like this. People are more accepting looking to make changes with in their own organizations. In print management, for us so you understand, I mean, we have designed the communication. We can separate through all the steps needed so it goes from that it is ready for production. We put on the right equipment in the right place across the world while still assuring that there is quality there and then we can use what I consider, again, another differentiator for its logistics, we saw us to go and have it delivered.

It is great that you go ahead and can print it but if you cannot get it done in a cost effective manner on a timely basis, that just nullifies everything else that you have done up to that point. We have got the ability to go ahead and do that and then we can track it with our software for our customers.

So, some of the announcement that you have seen lately with HMH and there are key for us and we think there is more opportunities like that that are out there that are going to avail themselves to us because our customers are starting to look and say, okay, I have got to do things differently now than what I was doing it.

And again, we are not the middleman. So, we can control our cost. We can control the operations. Others who want to do this as brokers, we think they are going have more different times in this environment to go ahead and do it because they are going to be relying on somebody else to do it. They are not going to be relying on themselves. They do not have the assets, they do have the funding capabilities nor do they have the logistic capabilities to go ahead and serve the customer. And at the end of the day, you need to have those in order to bring out the most efficient cost structure to your particular client.

Atin Agrawal - Longbow Capital

Okay. And when you look at next year, I think, I heard Miles, he talked about there are additional opportunities in terms of reducing the cost particularly from the recent acquisitions, but are there any other opportunities that you see reducing and expanding margins?

Thomas J. Quinlan III

Yes. I think every single line of our P&L gets look at and every single line of our P&L we will figure out how to go ahead and do things differently. I mean we are not immune to this like our customers are not immune to it and we have got to go and respond to it. And the nice thing is this management team has done that in the past and will continue to do it. I agree that these are times that I do not believe anyone has gone through so, it is going to take everyone's efforts going in the same direction to get us there.

Donnelley is what I like to think, we have got one company. We are united. We do not have silos. We use our equipment in the best possible manner. We are not going ahead in rewarding someone who has gone ahead and done it by themselves without including the rest of the platform. We look for ways to utilize those assets in the most efficient manner and as Miles talked about, those capacities opened up for us.

So, from a CapEx standpoint, talking about earlier trends, we have got some availability there where we do not have to go in and buy some of the big iron. Our digital technology and from a digital standpoint, we think we have got the best assets already that we can go ahead and fill up. So, we need to take advantage of that and we need to go ahead and continue to look to drive out so that shareholder value in the long term continues to be created and we can continue to deliver the results for you.

Atin Agrawal - Longbow Capital

Okay. And finally, any update on the acquisitions pipeline or?

Miles W. McHugh

Yes. I think again, we have continued to be disciplined. I think we talk about our three criteria that we looked at, was it due to the customer or what is the cost structure and does it add capacity and obviously, at this particular point in time, adding capacity is not something that we need in most of our product lines. Some of them are going pretty well from a capacity standpoint, others have freed up. So, I think as we look at deals that that are out there, that is going to come into play.

If you look at what is going on in our industry, you have still got people that are in bankruptcy court, you have got people that are coming out of bankruptcy that are basically going to be, what I would say, slightly constraint or very constraint and then you have got operations that are out there that are going to have to hit the debt markets and when they hit those debt markets, what are their interest costs going to be? One of the things that you can look at this tunnel that we are in, you could say, okay, it is a free train that light that is coming after you or maybe it is rainbow at the end of it. And obviously, we believe that there is some opportunities out there for us.

The differential in interest rate expense from somebody who is investment grade to someone who is non-investment grade is going to be very, very significant. I cannot tell you how many bases points today but I can tell you that when people have to go to the markets, when the credit markets open back up, do not lose sight of what those barring expenses are going to be because you cannot get rid of that. You cannot go ahead and change that.

Whatever the market is, it is going to bear for the money that you are going to have to borrow. That is what you have to pay. You have got to absorb that into your company. You have got to go ahead and try not to pass that along to customers. Again, I think that is an area where, as we go through 2009, it is going to be a benefit for us from a pricing standpoint.

Miles W. McHugh

You know, I’ll add to Tom’s point that that focus on maintaining our strong investment grade credit metrics, is more than just from the cost side, it helps us as we sit down with our customers and talk about longer term arrangement, print management deals that extend over the years and some of our longer term contract. It has been critical to us doing business. We thought about this and we talked about this as being a big level of importance to us over the last several years even when sometimes it was not in style to do and we continue to reap the benefits of it now and going forward. So, we are not straying from that.

Atin Agrawal - Longbow Capital

Okay. Just one more question. You reported that your sales increases in Asia and Latin America, can you provide more color, was it due to certain product or was it across the board?

Thomas J. Quinlan III

In Asia, it is somewhat across the board but as you know, Asia for us is, a big part of our business there is the export book business so that continues as well as our telecom technology. So, serving the telecom customers has been beneficial to us there. Latin America, it has been fairly across the board. There has been some impacts but underlying demands still remains good. So, in Latin America, it is not anyone particular part of our business.

Atin Agrawal - Longbow Capital

Okay, great. Thanks.

Thomas J. Quinlan III

Thank you.

Operator

Your next question comes from the line of Craig Huber with Barclays Capital.

Craig Huber - Barclays Capital

Yes. Good morning. First question about CapEx for 2009, do you think it is possible you can bring this CapEx spending next year down to about, say, $300 million.

Thomas J. Quinlan III

Good morning, Craig. Nice to hear your voice. I would tell you that we will look at that. Again, I think we are going to be probably somewhere around 3% this year of top line and I think if you take into account acquisitions and take into account capital in total, that is not out of the question at all and again, it think as we look at liquidity and one of the reasons Miles went into the detail was we want to make sure that everybody understands we included the schedule in the press release today regarding liquidating so that those type of concerns or questions by our shareholders that we can address them and answer them now. But again, that is another lever that we can go ahead and pull.

Miles W. McHugh

And there is also a good degree of, I would say, variability or responsiveness that we can take with that. As you saw, this year, we went into the year with a different environment that we came out with from our customer demand perspective and we were able to change our CapEx as we went through the year and so, I would expect that we would not have any different situation in 2009 where we should be able to adapt our CapEx spending ramping it up or down to suit the needs of the business.

Craig Huber - Barclays Capital

And my second question about this reduction and variable compensation expense. Yes, you mentioned it helped you margin by 277 basis points, I guess technically, that is $79 million to $80 million benefit. How should industrials think about it? Is that all just reversingly cool from the first half of this year or is part of the calculation of the 277 basis points, all for just the reduction year-over-year with the third quarter this year underlined versus a year ago?

Thomas J. Quinlan III

It’s the change over a year-ago but in this quarter we did reverse the accruals that we made in the first and second quarter of the year. And so, the quarter impact is I’ll say exaggerated, because you’re getting three-quarters of impact versus the amount in more like one-quarter’s amount in the prior.

Miles W. McHugh

And Craig, I think again just to stay there; I think again, this is a way that we align ourselves with our stockholders. If you’re not going to see from senior management all the way through plant workers, you know we participate in this together, we’re united on this, we– over the years– the last four years, we’ve been able to give holiday bonuses, we’ve been able to go ahead and discretion of 401K match, we’ve had Wincher payments, we’ve had NBO payments.

But again, all making sure first that we’ve gone ahead and reached the targets that we needed to reach for the people that have placed investments with us. This particular year obviously, the second-half of the third quarter and what we’re looking at coming down that’s going to be a very difficult challenge for us to do in 2008. So, again our employees understand, not that they like it but they understand what’s out there and how we reward them for performance when we perform and we have to pull back when the numbers aren’t there.

Craig Huber – Barclay’s Capital

Could I ask; how large was that overall bucket of costs a year ago? For all of 2007?

Miles W. McHugh

2007, we probably had close little bit over $100 million, I believe.

Dan Leib

Yes closer to– yes probably nearly $120 million.

Thomas J. Quinlan III

Including– if you include the 401K discretionary match, yes.

Craig Huber – Barclay’s Capital

Would you consider the only variable part of your labor costs?

Miles W. McHugh

No. No, I mean that I would not consider. I mean look, the things that you’ve been accustomed to over the years, whatever other companies you had followed, I mean we still– we take plans dark, we go ahead if we don’t have the work coming in; our employees understand that we need to go ahead and match cost to revenue. So we’ll act accordingly, we’ll get the plant in order so that when work comes back in. And we try to give our employees enough heads-up and enough notice that this is coming. So that it’s fair to them and they can plan.

So I would I tell you that I think what we’ve– through jump-lined and knots are leaders are the leaders here. We’ve been able to go ahead and make as much cost variable as we possibly can and we continue to look to see where we can make cost variable.

Craig Huber – Barclay’s Capital

My other line of question if I could. In your 10K– most recent 10K, you broke out your revenues; I guess into 11 sub-segments, I was wondering you’d be willing to just tell us the percent change between those revenue sub-segments in the quarter year-over-year?

Thomas J. Quinlan III

It’s going to be in the queue, which is going to be filed, I believe at the end of today. So we’ll have that in there.

Craig Huber – Barclay’s Capital

Great, thank you. And then my last thing is pricing. Is it fair to say pricing year-over-year, would you say a range would be down to 2 to 4% year-over-year on an average?

Thomas J. Quinlan III

I would tell you, Craig it depends on what products you may be looking at. I mean commercial print, as you can gather is brutal. From a commercial print standpoint, there’s a fragmented, obviously product line. And the transactional business is where it’s being hit most. What I’ll also tell you is that there’s larger corporate customers that are looking at the financial viability of their provider, i.e. the printer and looking to set up long-term contracts with the ones that are in good shape. So I think that’s going to end up helping us as we go forward there.

Dan Leib

Right and I think the level of impact of pricing hasn’t changed all that much from– in the current periods from prior periods. We’ve seen, as Tom said pricing coming down and impacting us in just about every year in the last five years for sure and probably longer than that. And it’s part of our business, part of our set up, it’s part of our planning to mitigate that every year. We know that going into 2009. So, the pricing wasn’t the area in the current period where we saw the drop-off, it was really volume and it wasn’t lost customers, it was lower volumes from the existing customers.

So it’s the past-through impact of the economic difficulties as it affects our customers, that’s affecting us. So, we’re well-positioned to rebound when the economy turns around but at the same time, we’re taking all these actions we’ve talked about to mitigate the impact in the current periods.

Miles W. McHugh

Craig, just to emphasize though, the commercial printing marketplace for– a person who has one product line, commercial printer, are going to have a very, very, very difficult times in this environment and that’s going to lead to opportunities for us. I mean we’ve got to– we sit here today and feel as we’re solid as any rock that’s out there and that the future for us does hold a lot of opportunity, because of the events that are taking place in today’s economy. There will continue to be consolidation in this marketplace, either through acquisitions or people that will exit the business.

Thomas J. Quinlan III

I’d say while we’re looking at those volume decreases, we’re not sitting back and just watching it happen. We’re probably 10% or less market share in the U.S. of the overall printing business. So there’s plenty of opportunity for our sales force to go out and get new business. New business from our existing customers and from new customers. So, while volume declines in the economic impact, it hit very quickly, it hit the country, the whole world very quickly in the quarter, as we have more time to adapt to it, we expect it will be able to fill out and continue to sell into what’s a very big market for us and hopefully use that in another area where we can mitigate some of this.

Craig Huber – Barclay’s Capital

I’m sorry to badger about this but, is a fair range for many of your categories pricing down roughly say 1 to 4% from a year ago?

Miles W. McHugh

I would probably say in the overall standpoint of things it’s not unreasonable, your high-end maybe a little bit high, the 4% but somewhere around there is not often. Again, we’ve got contracts with certain people; don’t forget that some of our businesses long-term in nature to where we’ve got contracts three years, five years, seven years so I mean that obviously pricing is reflected into those.

It’s the transactional business, Craig that I talk about with the commercial side, to where you’re really going to see this impact right now, because people don’t have enough volume to go ahead and put their presses. They’re making decisions that may– they may help them short-run but in the long-run they may not be able to meet their obligations as they’re going through things, which then are going roll-over to hurting vendors or suppliers who supply their business and sort of the dominos that start to fall with that will be fast and will many.

Craig Huber – Barclay’s Capital

Great, thank you very much.

Operator

Your next questions comes from the line of Jake Kemeny with Morgan Stanley.

Jake Kemeny - Morgan Stanley

Hi, thank you. Can you review your priorities for free cash-flow and specifically talk about your recent preference for sharing purchases versus that reduction given what’s going on in the credit market?

Thomas J. Quinlan III

Sure, our capital deployment, if there’s anything that’s been consistent here over these last number of years, is it that. We look to deploy capital in a prudent manner, we’ve look at acquisitions, investing back into the business, paying down debt, looking at repurchases as well. And the five drivers that we’ve always had we continue to have as I guess Miles and Dan Leib leave and I have to find a sixth, we’d appreciate it. But nothing out of the ordinary and again, we haven’t pulled any one lever, which again it set us up well for this time period. We haven’t gone ahead and you haven’t seen us gone out and do exorbitant amount of a stock buy-back. You haven’t seen us gone out and spend money unwisely on print acquisitions. We’ve been good stewards of this capital that we have and as you sit here today, this is going to be something to where we should be able to make one and one equal more than two, because of the position that we are in.

Dan Leib

And I can add, to go back I mentioned we generated in the first nine months of this year almost $700 million of operating cash-flow and we’re on track, the way we look at EBITDA CapEx to generate that proxy of free cash-flow of more than 15% growth over last year. So when you see the M&A environment that we talked about having more opportunities but at the same time, capacity and the need for that lowered on our side, we still have the ability to control where we put that significant cash-flow to work. And so far this year we’ve reduced short-term debt as well as made all the investments in the business that we wanted to.

So, we still see very good flexibility. Cash-flow continuing to be strong and plenty of opportunities, there’s plenty of availability to take advantage of opportunities as we need to but at the same time we look to be reducing short-term debt at the same. Making sure we have plenty of room to pay off that $400 million maturity that’s coming due in April. So we are in real good situation I think from that prospective.

Jake Kemeny - Morgan Stanley

Okay and I’m just trying to understand the operating leverage in the business a little better. Can you describe what your fixed costs are versus your variable costs?

Dan Leib

If you kind of break into– we talked about SG&A versus our kind of gross margin. SG&A we’ve been reducing quite a bit both from our ongoing efforts to drive productivity improvements. But also, that’s where a portion of our change and incentive condensation rolls through. The two biggest fixed costs that we have are cost of materials and cost of labor that are in our gross margin. And you’ll see– I’m sorry, the variable costs. But you’ll see that the benefits of the lower inflation we expect to come through next year.

In 2007, we had as everyone knows, very high energy costs, high commodity costs and those have very quickly moderated. And so we should be able to see some of the benefits of that drive through the business for the remainder of this year and next year.

Thomas J. Quinlan III

Yes, our scale drives it. I mean from IT to procurement , again we believe we’ve demonstrated to be a consistent track record of going ahead and managing costs and pulling the levers that we need to pull when we need to pull them.

Real estate, another big driver. We want to make sure every single square inch of property that we own or lease is revenue producing. And if it’s not, we need to take actions there accordingly. So scale for us, by being able to put the equivalent underneath one roof in the most efficient manner. Be able to distribute it in the most efficient manner, which again, those cost savings that we have, also benefit our customers, allows us to run the company the way we do.

Jake Kemeny - Morgan Stanley

Okay. And is there any reasonable scenario where revenue in your business could decline to such a point where you would just be breaking even on an operating income basis? Or do you have enough lee time to take the costs out of the business to keep a healthy margin?

Thomas J. Quinlan III

Yes, I would tell you, you know if you would have asked that question before August 15th, I might have given you a different answer. As we sit here today, I don’t think anybody should say nothing is impossible given what’s taken place in the world. But we’ve got– for certain product lines, we’ve got visibility. That doesn’t mean that they can’t go ahead and change at the midnight hour.

Other product lines which those of you who are familiar with the industry know that those particular jobs come in, you’ll walk into the plant that week, you may not have anything on the board that’s going to be going on and then all of a sudden you get– sales come through and we get four or five jobs that hit that take up the rest of the plant.

So our visibility and the way we manage the business allows us to continue to stay ahead. And that’s what we need to do is continue to stay ahead of what’s taking place out there in the marketplace.

Jake Kemeny - Morgan Stanley

One last one if I can. Do you track capacity utilization?

Thomas J. Quinlan III

Obviously we do, we don’t talk about it, because I think that’s something that no need to tell everybody else what we’ve got going on in our own house. But we track it and we make sure that we’re utilizing these presses in the most– again, the famous ray’s most efficient manner possible. And again, that helps us give us the returns that we’re able to give to you.

The way we manage that, if you look at our business and this is not the old R.R. Donnelley and I keep harping on that. But if– we have the ability to go ahead and load these pieces of equipment from digital to long-run to web to off-set, you name it. We get a chance to look across the whole platform, look across where in the world needs to get done and then look to see where in that particular region is the most cost effective to go ahead and have it produced. And by having that one R.R. Donnelley, it pays dividends for us.

Jake Kemeny - Morgan Stanley

Thank you very much for your time.

Miles W. McHugh

Operator, we’ve got time for one more.

Operator

Our final question comes from the line of Edward Atorino with Benchmark.

Edward Atorino - Benchmark Company

A couple of quickies. One, head-counts, sort of year-over-year ProForma. Number two, a little D&A as the percent of sales go down a little bit and if CapEx goes down. And thirdly, what are the actual shares outstanding at the end of the third quarter.

Thomas J. Quinlan III

I guess the first shall also be last as well. From a head-count perspective in the Q-end K, we’re still north of 60,000 employees worldwide. And I’ll let Miles take over some of the other ones.

Edward Atorino - Benchmark Company

Is that down a little bit?

Miles W. McHugh

You know, look it’s– yes, I mean everyday our– you know we have changes in head-count here, it’s not–

Edward Atorino - Benchmark Company

Okay, gotcha. Thanks.

Thomas J. Quinlan III

Okay for D&A we still are on track for $650 million of D&A for the year and that includes $130 million of purchase accounting amortization. So no significant change there. And then last question?

Edward Atorino - Benchmark Company

Actual shares– you know the average shares with 2097 fully diluted, what were the actual?

Dan Leib

It’s 205 million in round numbers where we–

Edward Atorino - Benchmark Company

And that would be the fourth quarter number then?

Dan Leib

It should be where we’re at now at the end the third quarter right now.

Edward Atorino - Benchmark Company

205, right.

Thomas J. Quinlan III

Thank you, everyone. I appreciate you taking the time to join the call today.

Operator

Thank you for participating in today’s third quarter 2008 financial results conference call.

.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!