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

Q1 2009 Earnings Call

May 06, 2009 10:00 AM ET

Executives

Dan Leib - Senior Vice President, Treasurer

Thomas J. Quinlan III - President, Chief Executive Officer

Miles W. McHugh - Chief Financial Officer, Executive Vice President

Analysts

Charles Strauzer - CJS Securities

Craig Huber - Barclays Capital

Eugene Fox - Cardinal Capital

Operator

Good morning. My name is Marcus (ph) and I'll be your conference operator today. At this time, I would like to welcome everyone to the R.R. Donnelley First Quarter 2009 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question and answer session. (Operator Instructions). Thank you.

Mr. Leib, you may begin your conference.

Dan Leib

Thank you. Good morning and thank you for joining us for R.R. Donnelley's first quarter 2009 earnings conference call. Earlier this morning, we released our earnings report, a copy of which can be found in the Investor section of our website at www.rrdonnelley.com.

During this call, we'll 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 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 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 and good morning everyone. I'll begin by briefly addressing the following; the impact of the global recession on revenues, our very strong cash flow, and our ongoing cost containment initiatives.

Miles will then discuss the first quarter in more detail and I'll return with a couple of comments. We'll then open it up for questions.

My first topic is the impact of the global recession on revenues. Though economists suggest that the recession had already begun by the first quarter of 2008, we felt only mild impacts from it during the first half of that year. So our recently completed quarter offers a clear contrast with pre-recession performance.

During the first quarter, the full impact of the challenging economic environment manifested itself and significantly reduced demand across all the sectors that we serve. As our customers aggressively curtailed their spending, our revenue fell approximately 18%, negatively impacting EPS despite benefits of our productivity efforts. Part of this revenue decline, approximately 3.5%, was a function of currency fluctuations yielding a like-for-like sales decrease of about 15%.

Let me be very clear about our top-line performance. It was not impacted by business being lost to competitors. Rather, it was drive customers reducing, delaying and eliminating programs. For example, states and local school districts have put off approving and ordering new text books in response to budget shortfalls. As a result, we believe that some impact on revenues is from deferred demand and short term spending reductions, rather from a fundamental and permanent shift in communication strategies.

This brings me to our second topic, our very strong cash flow. During the quarter, cash from continuing operations was 539 million, up more than 300% from the same quarter a year ago. We have indicated that we are battling through this economic downturn by focusing on maintaining strong liquidity and achieving operational excellence as we serve our customers. I remain confident in that strategy and in our ability to execute it.

We're on track to generate at least 700 million of free cash flow this year as we projected back in February. Our Q1 cash flow performance reflects our intense efforts in managing working capital, a non-recurring tax benefit, lower capital spending and the suspension of all of our performance bonuses in 2008.

The third topic I want to address is cost containment. As this management team has always done and will continue to do, we are aggressively managing our cost and controlling ways each hour of every day. In addition to our usual cost management practices, we are pursuing a measured approach to taking out excess capacity and reducing our fixed cost infrastructure, all while continuing to meet and exceed our customers' expectations for service.

We've consolidated a number of operations in Europe and in the United States. We executed these consolidations in a controlled manner using a capacity management process that supports increased demand and that includes contingency plans for unanticipated decreases. We will continue to balance the realities of today's demand outlook with what we anticipate our customers would do when the economic conditions improve.

Similarly, we are not compromising any processes that impact our environmental, safety or quality performance. It's important to note that as we keep our platform in sync with customers' changing needs, we're also increasing the mix of digital printing units, all of those that are commercially available and those that are proprietary across our global platform.

In fact, we believe that we have the world's largest integrated fleet of digital devices with more than 1000 units deployed in over 60 facilities around the world. The ongoing expansion of our digital platform is a great example of how we are meeting customers' evolving need while, at the same time, driving production efficiencies.

Our platform in IT networks allows us to use the right assets, for the right customers, at the right time, in the right place. To more efficiently bring our capabilities to our customers and prospects and to reduce our SG&A cost, we continue to refine our sales organization. We have brought senior leadership closer to the action by collapsing layers, we'd continue to direct and incent our sales team to increase incremental revenue by selling the full breath of our product and service lines to all of our customers.

And finally, we've organized specifically to address selected target accounts that can fully utilize our unmatched global products and services platform. These are ideal candidates for our One R.R. Donnelley strategy.

With that, I will turn it over to Miles.

Miles W. McHugh

Thanks Tom. I will provide a detailed review of our first quarter results. The first quarter was, as expected, very challenging on the top-line with a continuation of the sales trend we saw in the back half of the fourth quarter of last year. We did see some stabilization at this lower level throughout the quarter and at the end of the month of April. Our 2008 comparisons will continue to ease as the year progresses because we felt the most acute impact of the current recession in the back half 2008 and, in particular, in the fourth quarter.

In the first quarter of 2009, non-GAAP earnings per diluted share were $0.24, compared to $0.69 a year ago. We are pleased with the exceptional cash generation in the quarter. We generated $539 million in cash from operations, an increase of $413 million from last year's first quarter. We received, as expected, most of the $165 million cash tax benefit related to the decline in value and reorganization of certain entities within our international segment that we discussed on our fourth quarter 2008 earnings call.

Additionally, our first quarter cash flow comparison to prior year was favorable as we did not have 2008 incentive compensation payments in the first quarter of 2009, while we did have 2007 incentive compensation payments, totaling approximately $115 million in Q1 2008.

We also made progress as planned on our working capital initiatives and freed up more cash from working capital due, in part, to lower sales volume.

Now let's move on to our non-GAAP results for the quarter. Consolidated net sales in the first quarter were $2.5 billion, down 18.1% from the first quarter of 2008 results or 14.6% excluding the impact to foreign exchange. The lower sales were due, primarily, to lower volume as well as continued price pressure. Changes in paper prices did not significantly impact our revenues.

Our gross margin was 23.3% in the first quarter of this year, compared to 26.0% in the first quarter of 2008. This decrease of approximately 266 basis points was due to volume and mix declines, continued price pressure and lower by-product recoveries, which were partially a function of the volume decline, but more importantly, due to lower demand for print related by-products. These decreases were only partially offset by the benefits of our continued cost management efforts and a reduction in variable compensation expense.

Our SG&A, as a percentage of revenue, was 11.5%, the same percentage as in the first quarter of 2008. This was largely due to the benefits of cost management efforts that offset the impact from the sales decline. In both, our operating segments and in Corporate, we continue to focus on controlling variable SG&A costs to match expenses with revenue.

We generated approximately $290 million in EBITDA, a decrease of about $145 million from the first quarter of 2008. This equates to a decremental margin of 26.7% on the reported sales results. As I mentioned during the fourth quarter 2008 earnings call, there are many factors that will determine the bottom-line impact from the given revenue change. Factors such as changes in pricing, duration and severity of revenue change, product mix, foreign exchange, changes in commodity prices and the resulting by-product impact, bad debt provisions, benefit plan expenses and variable compensation to name just a few.

For volume increases or decreases, we do have a fair amount of variable cost in our cost structure and would expect the decremental margin percentage in the range of from the high 20s to the mid 30s in 2009.

Depreciation and amortization expense in the first quarter of 2009 was approximately $10 million lower than one year ago, primarily due to the intangible asset impairments recognized in the fourth quarter of 2008 and lower capital expenditures.

The GAAP operating margin, including restructuring and impairment charges, was approximately $87 million in the first quarter of 2009, compared to about $270 million in the first quarter of the prior year. Excluding the restructuring and impairment charges, non-GAAP operating margins decreased 346 basis points from the first quarter of 2008 to 5.8%. Volume drops and price pressure as well as lower by-products recovery, more than offset the benefits of our productivity and cost takeout initiatives and the variable compensation expense reduction. Change in foreign exchange rates increased operating margin slightly by 21 basis points in the quarter. Net interest expense was $59 million in the quarter, $2 million higher than the first quarter of 2008, primarily due to interest on the 400 million of notes we issued in January 2009 and lower international income ... interest income as a result of lower average interest rates, partially offset by lower average short-term borrowings.

Our GAAP effective tax rate in the first quarter of 2009 was 41.4% and was higher than the effective tax rate of 16.3% in the same period last year due to a $38 million tax benefit recognized in the first quarter of 2008 from the favorable settlement of certain Federal income tax audits for the years 2000 through 2002, as well as a loss of tax benefits in certain foreign tax jurisdictions in 2009. On a non-GAAP basis, the tax rate increased to 37.1% in the first quarter of 2009 from 33.8% for the same period last year due to the loss of tax benefits in certain foreign tax jurisdictions in 2009.

Now, let's turn to the first quarter operating results by segment. Sales of our U.S. Print and Related Services segment declined 14.9% to $1.9 billion for the quarter, while pro forma for acquisitions, sales decreased 15.8%. The most substantial volume drops versus the first quarter of 2008, came from our four color book, capital markets related financial print, commercial print, catalogue, magazine and retail, logistics and direct mail product offerings. Additionally, our forms and labels business continue to experience accelerated pricing pressure.

Non-GAAP operating margins decreased by 443 basis points to 7.7% in the first quarter of 2009. Our continued focus on productivity and cost management initiatives, combined with the variable compensation expense reduction, partially offset declining volume, price pressure and lower demand for print-related by-products.

Our International segments reported sales were up 27.5% or 14.3% on a pro forma basis, excluding ... including acquisitions and excluding foreign exchange impacts, to $548 million due to volumes declines across most product lines and price pressure, notably in Europe and Asia. We continue to see volume growth in Latin America.

Similar to last quarter, our biggest volume drops in the quarter came primarily from decreases and demand from our technology clients within our Global Turnkey Solutions offering as well as from a dramatic drop in volume as a result of the lack of M&A activity in foreign markets in which we serve in our financial print offering.

Non-GAAP operating margins declined 50 basis points to 6.3% in the first quarter of 2009, as continued volume drops in price pressure were partially offset by productivity initiatives, lower amortization expense due to the intangible asset impairments recognized in the fourth quarter of 2008 and the variable compensation expense reduction. While foreign exchange rates negatively impact our sales growth, they improved non-GAAP operating margins in our International segment by 90 basis points.

Finally, excluding restructuring and impairment charges, our Unallocated Corporate expenses decreased $7 million from the last year's first quarter due to continued cost control efforts across all functions and the elimination of the company 401k match in 2009. During the first quarter of 2009, we spent $55 million on capital expenditures, a decrease of $17 million compared with the first quarter a year ago as we leveraged our capacity and infrastructure. We continue our rigorous review of all capital and cash expenditures and require justification for each dollar spent; a discipline that has allowed us to maintain very strong balance sheet and liquidity profile through these particularly difficult times.

As we show on the last schedule of our earnings release, we had net available liquidity of $2.6 billion at the end of the first quarter of 2009, an increase of over $1 billion from the first quarter of 2008. Subsequent to quarter-end, on April 1, 2009, we paid out $400 million to fund our bond maturity resulting in the remaining cash and cash equivalents balance of $625 million, which is just over $400 million is located overseas and would be taxable if we page it ahead (ph) to the United States.

Following the repayment of our April 1st maturity, our debt is approximately 90% fixed at an average rate of 6.3%. As I mentioned on our call last February, we expect our 2009 cash flow from operations plus CapEx to be greater in 2009 than last year's almost $700 million. We expect this strong 2009 cash flow and our current liquidity and committed credit facility, we're well positioned as we plan for upcoming debt maturities in 2010 and 2012. We have no term debt coming due in 2011.

On our fourth quarter earnings call this past February, we discussed our estimated pension funding requirements. In late March, the IRS issued a clarification on the discount rate which used to value pension obligations. Our expectation now is that our required pension funding would be substantially less than the $155 million in 2010 that we communicated previously, potentially as lower as the 2009 contribution.

Our 2009 contribution is still expected to be only $22 million compared to the $40 million we contributed in 2008. We currently expect to recognize pension income of $6 million in 2009. There are still a lot of discussions going on in Washington and throughout the country regarding possible pension related changes. Therefore we will continue to track developments closely and adapt our plans if circumstances change or opportunities arise.

For 2010 and beyond, investment performance and discount rates will determine the future required cash contributions. Much will depend on the times of the contributions and market conditions. We will continue to evaluate the most opportune time to fund our pension obligations.

While visibility remains challenging, the top-line appears to be stabilizing at this lower level. Given the stronger relative performance in the second quarter and early third quarter last year, we would we expect comparables on the top-line to be as challenging in the second quarter and to improve in the third, and further into the fourth quarter of 2009. Our decremental period-over-period margin, which we can typically manage to a percentage range between a high 20s to 30s, will be adversely impacted in the third quarter given the large incentive compensation reversals recognized in the third quarter of 2008.

We expect these first quarter bottom-line results to be the low point for the year with modest improvement in the second quarter as we benefit from some of our productivity efforts. Due, in part, to the timing of the most severe impact of the recession in the third and fourth quarters of last year, as well as the normal top-line seasonality and productivity actions that we have taken, we would expect the third and fourth quarters to show continued operational and earnings improvement, taking into consideration the large incentive benefits recorded in last year's third quarter.

And while we're not providing earnings guidance, we will share with you some of what we're expecting in 2009. Depreciation and amortization expense of approximately $590 million. For interest expense our fixed rate debt has an average interest rate of 6.3%. Our invested cash earns a low rate of return and our variable debt is expected to be at an average rate of 2 to 3%.

A non-GAAP tax rate of approximately 36%, although this estimate could be significantly impacted by business trends affecting different countries in which we do business or by changes in tax law. A fully diluted share base of approximately 207 million shares for the full year. We continue to expect 2009 capital expenditures to be approximately $250 million, a more than $70 million decrease from 2008 and about $230 million lower than 2007.

Corporate expense is expected to be in the range of $150 million to $160 million. Although this range could be significantly impacted by changes in our LIFO inventory provisions, bad debt expense and healthcare trend costs. We will continue to focus on credit exposure with our customers at times of bulking up (ph) changes in payment terms if changes occur in their financial health. For many customers, our printing is critical to their business and they, therefore, make every effort to continue to pay us for our work.

While we expect 2009 to be a challenging year for earnings, as we mentioned, we expect strong cash flow performance. We expect to continue to make progress in working capital management. We've targeted improvements in this area, assigned accountabilities and linked incentive compensation at these improvements.

Again, in total, we expect to deliver higher cash from operations, less CapEx in 2009 than the almost $700 million we generated in 2008. Since the end of March 2008, and adjusting for our April 1, 2009 debt repayment, we have reduced our debt by $460 million and reduced our net debt by $684 million.

We will continue to focus on liquidity and debt reduction in this environment. Maintaining our investment rate credit metrics is very important to us and to many of our customers. We are targeting a debt to EBITDA ratio of 2.0 time s to 2.5 times on a sustainable basis, recognizing that some economic environments will be at the high end or above the ratio.

And with that, I will turn you to Tom.

Thomas J. Quinlan III

Thank you, Miles. Before we open it up for questions I would like to make you a few brief points. First, R.R. Donnelley continues to hold the unique position in our industry. As we have said before, the economic slowdown is removing excess capacity from our industry. Some facilities are simply exiting the industry while others, based on what is being presented to us, are trying to find a Safe Harbor by being acquired. As we've said before, we have not yet seen a compelling fit with our strategy among these offers.

We believe that we entered the downturn in the best position in our industry, for two important and connected reasons; one, our financial strength, and two, our ability to deliver end-to-end all encompassing solutions. As customers everywhere respond to economic challenges by consolidating their purchases, simplifying their processes, modifying their products and streamlining their procedures, we believe that no other company in the business has the resources to help them the way that R. R. Donnelley can.

I would never suggest that we are without competitors; in fact, the printing industry remains highly fragmented. However, as customers consider how to fully leverage their printing related spend, while still maintaining flexibility, quality and control, we believe that R. R. Donnelley's global offering remains superior and net gap is widening. Related to this is a positive consequence of the challenged economic environment.

Customers everywhere are feeling the impact of the downturn and are looking for cost savings. As a result, many organizations that have not previously been open to exploring our integrated print management approach are taking a second look as they consider the savings that they can realize by aggregating their spends and by evaluating the total cost of ownership of their products. They are seeing that R. R. Donnelley offers two key differentiators, our unparallel global platform and our financial strength.

Now when customers enter into an integrated print management agreement with us, they almost always use our internet-based custom point system. Among its main capabilities, custom point allows customers to enter self-serve orders for digitally printed and other materials.

Orders that we receive through custom point were up in the quarter by 11.6% sequentially as compared with Q4 of 2008 and March orders were up 23% as compared with the same month a year ago. We see this as a leading indicator that customers are becoming more open to using our approach and technology to drive efficiencies and to reduce their total cost of product ownership.

My second comment is that R. R. Donnelley development pipeline continues to produce innovative digital solutions. Our most recent announcement, that we have achieved a technology breakthrough that will bring offset flexibility and economics to inkjet imaging is worth revisiting. Variable imaging plays an important role in a broad spectrum of applications from direct response mailings to barcoded labels. So, this proprietary capability will play a role across the full range of customers' business activities. It will help them acquire and retain customers and fulfill their orders.

This technology blends the best of both worlds. It provides variability at a cost and quality more acquainted to additional offset inks. It's been developed in house by our own engineering team, and again this proprietary breakthrough will add to the significantly PAT (ph) portfolio that we hold in the printing systems area, giving us unique advantages in the fast growing digital printing space. Applying inkjets in creative and more affordable ways also opens the door to applications that involve even more in putting ink on paper. We expect to deploy this patented technology within our platform in 2010 and beyond.

Coming on the heels of our introduction of the world's first 1200 DPI Four Color Digital Press, this latest innovation demonstrates that we're moving aggressively to take full advantage of the opportunities that digital printing presents. Please note that this new technology does not replace conventional printing.

In fact, it extends that range of applications for conventional printing by enhancing the speed, flexibility and affordability of spot variable digital content. So this new technology works in concert with conventional printing. As we retrofit units, we believe that we will extend the range of applications that conventional press is concerned of bringing them into the digital world with our commensurate need for more significant CapEx.

Finally, I'd like to close with thanking our employees for their efforts in this very challenging environment. We continued to regard safety as first and most important indication of our operational excellence. One measure of the way that our employees continue to shake off distractions and focus on the business is reflected in our safety performance, which I'm grateful to say, continues to be very strong.

And now, operator, let's open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Your first question comes from the line of Charlie Strauzer with CJS Securities.

Charles Strauzer - CJS Securities

Hi, good morning.

Unidentified Company Speaker

Good morning, Charlie.

Charles Strauzer - CJS Securities

Hey Tom, quick, couple of quick questions for you, I mean, you and Miles went through a flavor of the top-line trends. If you could maybe explain a little bit when you look at April hearing totally that there are some signs of life again in terms of maybe that Q1 was at bottom in terms of the rate of decline in the industry. And also with the upcoming proposal by the U.S. Postal Service to propose a discount to standard mailers and maybe extend on that potentially when you talk to customers, are they intrigued by that?

Thomas Quinlan III

Sure, Charlie, thank you. First, let me back up probably a little bit on enactive (ph), the first quarter was not a surprise for us from the standpoint of where the numbers ended up coming up from a top-line standpoint. We knew that this was going to be a period where it was going to be tough to go ahead and stomach but our industry needs to go through this.

It is still a highly fragmented industry. In order to get this industry where it should be, this time period is going to have to take place and again because of where we're at, because of what we've built here, because of the product offering we have, we feel very confident that we're going to be able to come ... go into this as we're going into it to come out of it, even in a better position than what we were.

So I would tell you that our customers, the meetings that we're having with them, they are positive. And one of the reasons for me to be particularly upbeat today as we sit in front of you is that we're having good meetings with customers, meetings that again I would tell that we've been trying for years since we got here to and since we built the platform to say, look, this is what we have built, this is what we can do for you.

Now it comes into play, now we can go ahead and show you, demonstrate here the savings we can do for you, here is the efficiencies that we can bring forward to you and whether you are a magazine book publisher, you do other printing, you do other communication neat, we can help you there and we can bring our scale to bear.

The same thing on the flip side, when you look at the corporate clientele that we have, people were hesitating to fine okay, I am going to look give you 100% on what I'm looking to do. Now those discussions are taking place more frequently than they have and we do think that we're going to have some good things coming down here for the rest of the year.

So, from a top-line standpoint, I would tell that we feel good as far as what's going on. I mean if you look at inventories are down, consumption starting to pick up, those are all good things for us. This is got to be ... the consumer's got to come back into play for all of us to feel good.

Do I think it could be a jobless recovery? I don't know. I'm not smart enough to tell you that, but if that consumer comes back with the inventory levels being where they are, down, people are going to want to start to advertise more, brand more. That's a big vertical that we plan. You're going to continue to have the compliance take place that is currently taking place, where they're with that.

And then obviously you've got the regular business model where you've got people that have to print in order for them to get revenue, all those things we're set up for, all those things we get up for. With on the postal question, I commend all this to Mr. Potter for his actions. He didn't go looking for a bail-out by the United States Government; he came in and said, hey, look, let's offer more of a carrot approach. What that's going to mean for our customers is going to be interesting. It should be something to where people will look to avail themselves to it. I think it's too early for us to tell you that, hey, this is going to something that's really going to take off, but I can't tell you, without a doubt, our customers appreciate it, we appreciate it and we're, again, look that that will be somewhat of a positive as we go through the rest of the year.

Charles Strauzer - CJS Securities

Got it, and then the U.S. base, I think, proposed about a 20 to 30% discount over the summer period to try and entice people to get more standard mail in the system?

Thomas Quinlan III

They are Charlie and I think the bigger thing there is, again, it's going to be ... it's formula based, you're going to have to go back and look at what you mailed the prior year, look what you're mailing this year, they'll compare that to ... they also don't want to see people put mail, accelerate mail into, what I call, the summer months and pull it from the back end of the year, so all those come into place.

But again, from a logistics standpoint for us, there's no one out there that has the scale or density that we have that can help mitigate the increases that are going to, don't forget at mail level there's a 3.9% increase across all ... on average across all places of mail, but again I think the way we can maximize the postal discount is a huge benefit to our customers.

And if you look at what ... again to stay on this and to beat it up, I mean the intelligent mail that USP has out there, we're going to be a big player and that we already are right now and we've got the ability to go ahead and take our intelligent mail platform to augment the benefits of that offsetting the costs that our customers are going to see from a postal standpoint.

We've got Polybag going out, we got Copal portrait. We're doing everything but putting the mail on your door step. We're automating ... we've automated ourselves for the USPS so that are customers can get the benefit and that at the same time give them the opportunities that they need to take the cost out of their structure because that still has to take place for all of us as well.

Charles Strauzer - CJS Securities

Then speaking of, Tom, to the competitive environment I know you've seen some high profile companies either closing their doors or talk about restructurings couple of quarters obviously has started to put forward a timeframe of existing from bankruptcy; talk a little bit more, are you seeing a little bit more than acceleration on the contraction that we'd hope to expect?

Thomas Quinlan III

Yeah. I mean again this is when we got here in 2004, if you placed this out, we look at we would be one of the drivers to consolidate this industry. And obviously, the economic conditions that have taken place, don't allow us to play that role to the extent that we thought we were going to play it back then.

However, the economy is going ahead and consolidating the industry on everyone's behalf. And I think if you look at the number of facilities that are exiting, the people of that, have the, what I call, the mum and pops again, less than $250 million of top-line. Family-owned businesses that now may have an opportunity to monetize their business now don't have that opportunity anymore. They are not meeting payroll.

The great thing for us as we sit here, we're talking about growth, we're talking about technology, we're working with our partners to evolve print and evolve distribution. Clerical world is an indicator that is coming out of bankruptcy. We've seen them, we've completed against them. We don't know what form or shape they'll come out but they'll be up again.

A lot of our challenged partners, or I should say, challenged printers that are out there are competing on price and price alone and that's not something that's going to sustain you over the long-term. And for us, not having to compete on price alone, is a huge differentiator in benefit for us and our customers as we look to come out of this.

Charles Strauzer - CJS Securities

Got it. And then just one question for Miles, real quick. SG&A sequentially jumped about 10 million. How should we think about that through the rest of the year?

Miles McHugh

SG&A as a percentage of revenues was flat and I think the way to look at is that we still believe we have the ability to match SG&A as a percentage of revenue. So, it may go up if ... when revenues accelerate. But for the most part, we still think we can keep a stable ratio.

Thomas Quinlan III

Just to add onto what Miles said there I mean we did not, in the good times that we had here, we did not overbuild this platform. So, you did not see us go ahead and add, what I'd call, unnecessary capacity at the time like some others did. And as the time period that we're going through right now you are also not going to see us go ahead and cut this thing to the bone, because we do believe that there will a rebound here and we want to be ready for us to go ahead and take a significant amount of cost out right now at this time period, I do not believe is a good idea.

We've probably taken out about 10% of the workforce over the last 15 months, as you'll see when we file the Q later, there is about 2700 people that we've announced in the first quarter that will see the benefit for it in the back half, the next nine months.

But again, we still got leverage that we can pull and we still believe that the way that this platform is built, where we are situated, how our distribution model goes, we should come out as a stronger when in fact there is a rebound. Doesn't mean I'm going to have the patience that's going to last for ever. But it does mean that right now we've got the ability, the flexibility to loop this thing out a little bit longer.

Charles Strauzer - CJS Securities

Let's say in another way you have the ability if the economy were to take up a leg down instead of taking a leg up, to take further cause that and for the capacity as needed?

Thomas Quinlan III

Yes, we do.

Charles Strauzer - CJS Securities

Okay, thank you very much.

Operator

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

Thomas Quinlan III

Good morning, Craig.

Craig Huber - Barclays Capital

Hey Tom, few questions, let's go one by one if you could. This call and prior calls you talk a decent lot about market share, everybody seems to have different numbers, what is your thought on what R.R. Donnelley's U.S. or North America market share is to the areas you compete in?

Thomas Quinlan III

I don't think I've used the term market share but I would tell that we've gone ahead and if you think about ... again these are numbers that were probably 2007. If you think about a $175 billion industry in the U.S. and if you back out newspapers which at the time, they were probably what these numbers but the time will probably about $30 million of that ... $30 billion of that and then here cut that for what everything that's going on and let's say we're sitting here right now with a $120 billion marketplace that is out there from where we're competing, not including our services that we can do offshore with both digital management as well as with analytics. We're probably 8 billion in the U.S. right now, 8.9, 9 billions I mean huge opportunity there for us to get more of our ... more of that spend onto our assets and for us to manage.

Craig Huber - Barclays Capital

Okay. Then totally separate question and I realize you obviously don't put together the accounting rules out there, but just talking about the restructuring charges, I mean, just looking at my earnings model, I mean, back to at least 2004 every quarter R. R. Donnelley's had a restructuring charge that shows up in the income statement.

And I realize other companies following others do this, have the same thing or in your times as a restructuring charge mostly every quarter as well. I guess from my view of point I guess it's one thing of the company's restructuring charge roughly once every five years, but this is happens every single quarter, how are you able to categories since restructuring supposed just to ongoing expense to rationalize the cost base?

Miles McHugh

Yeah, there are specific accounting rules about that and we follow them closely and so that characterization is appropriate. The way we look at restructuring internally is to look at it like we would any other cash investment because that's what it really is and for us it's an investment in the future cost savings or future productivity improvement.

And so, we mentioned it earlier, every time we spend whether it's CapEx, whether it's an investment in restructuring to cut cost and improve productivity, new facilities whatever they maybe we look at them on return on investment. There are all the normal just kind of cash flow basis to make sure that we're spending our cash wisely. So, that's the way we look at restructuring charges.

Thomas Quinlan III

Hey Russell, I'm sorry, Greg, you know that 2007, 2008 $700 million of free cash flow, 2009 we'll forecast on that. Some of the other companies that you've mentioned, I don't think I would put in where we are from a financial standpoint given the numbers that we've actually have in cash is going to look that's a good barometer of how someone is doing.

Miles McHugh

IF I could add to that, over the past five years we've done a lot of acquisitions as we further improve our scale and those acquisitions come with them plans for when we acquire the businesses to restructure them. So, the restructuring in great degree is a planned activity that's part of our acquisition process and not an entirely reactive process to how the business is doing.

Craig Huber - Barclays Capital

Okay. I appreciate that and totally separate question, can you talk a little bit about the dividend in the last quarter commerce price (ph) reevaluated each quarter but there's no mention of it in the press release. Could you talk about the outlook here for your dividend?

And then along the same line, earlier this year you guys made a decision to mark in your another $400 million of long-term debt at 11.25%, I guess as opposed to using your bank revolver, and if you could mention the variable rate on that is about 2 to 3%, what was the reason to spend ... encourage this expense 11.75% as opposed to just a simple 2 to 3% of your bank client, bank clients have $2 billion largely on TARP and stuff (ph), why would you guys just save that 8 percentage point to go to bank revolver out?

Thomas Quinlan III

Sure, let me start the dividend then we'll roll in to the decision on the capital markets. Again, it's the answer that you've heard from Miles, continue to hear first that you are going to continue to from me is that we continue to evaluate all that deployment capital including the ongoing payment of our quarterly dividend.

Again, to ensure we maintain strong liquidity and operational flexibility. I've got $700 million of what we thing of free cash flow out there, we want to make sure that we return, get a return back to the shareholders and if an event takes place and maybe we'll comeback and look at the dividend and the event could be an acquisition. If the markets turn further down, we still have the flexibility that we can take action with the dividend.

Again, each and every decision that we make there is for to make sure that we get returned to all of our stakeholders. So that will continue to be will the way we will monitor that and regarding the decision that due to long-term debt piece, look, at the time its 10% of our outstanding debt; if we go back in time it's always good to have Monday morning quarter back and we do that a lot here. But again if freed up ... we don't have any questions to ask regarding financial flexibility from now to 2012.

So I think when one could say, hey, it's expensive I mean 10% debt, 10 year debt normal times what would you pay, 8% so, may able to 300 basis points or over. I'd love to think we had the opportunity to be, I don't think its fair to see 900 basis points over but 300 basis points over for that insurance policy so that we can wake up everyday, we can open these doors and continue to invest in the business that we were investing in it. We felt the prudent action to go ahead and take with love, with love.

How great would it be for the economy to pick up and somebody wants to come back and tell me, Quinlan you made a horrible mistake by going out in 10-year money at 11%. If in fact this economy starts to pick up it sure is going to be good news for us and for everybody else.

Craig Huber - Barclays Capital

And then totally separate last question about the working capital, could you just give Industrial better flavor of the working capital benefit in the first quarter was larger just because of the downturn on the top-line or just the moving pieces there please?

Miles McHugh

Sure. In part it was because of the reduction in our top-line but even beyond that, we've been targeting this year as I mentioned a lot of programs in place to improve that from reducing days outstanding, earn receivables to better inventory management to additional stuffs on the accounts payable side. We're hitting it from all directions, we're looking at it from all ways and we've tightened to incentive compensation both from our sales force at the print level or throughout the company and that even more focused approach is driving working capital improvement even beyond the amount that would normally come from just a reduction in the top-line.

Craig Huber - Barclays Capital

Then lastly, if I could, just looking for four numbers, for each of the quarters last year, could you remind us with the incentive compensation cost would have you booked to your P&L, do you have those or maybe if you could give that?

Miles McHugh

We don't know.

Craig Huber - Barclays Capital

Okay. That's all I have. Thank you.

Thomas Quinlan III

Thank you.

Operator

Your next question comes from the line Eugene Fox for Cardinal Capital.

Thomas Quinlan III

Good morning.

Eugene Fox - Cardinal Capital

Hi gentlemen.

Eugene Fox - Cardinal Capital

I apologize if any of these have been asked already. Your estimate Miles for share-based comp expense for the year in the quarter?

Miles McHugh

Yeah. It is in the 10-Q but we don't have estimates going forward on it.

Eugene Fox - Cardinal Capital

So you don't have that. Do you have your bad debt expense for the quarter?

Miles McHugh

Yes. We'll get that while I answer ... 9 million for the quarter on bad debt expense and then for last year's quarters to answer Craig's question on the incentive comp, we had about $31 million in Q1 '08, 33 million in Q2 of '08, a reversal of 38 million in Q3 of '08, and the reversal of 10 million in Q4 of '08.

Thomas Quinlan III

Anything else?

Eugene Fox - Cardinal Capital

Sure, Tom, I don't believe you've indicated, any idea what the annualized savings would be for the actions that you would have taken over the last quarter or perhaps in the last six months going forward?

Thomas Quinlan III

Yes, if you've followed us for a while, you know that I've stopped given out those numbers. Just no again, I think we've proved ourselves from across standpoints, as far as what we're taken out. You'll see the Q, you'll see how many people unfortunately had to leave the company. Our scale, that is a benefit for us when things are going up as we've talked about and when things are going down, you don't enjoy the scale that should like to have because of volume is not there. But on the whole, I think we can feel comfortable that we manage cost better than anybody else.

Eugene Fox - Cardinal Capital

Thanks Tom.

Thomas Quinlan III

Thank you.

Operator

(Operator Instructions). Your next question comes from Jake Kemy (ph) with Morgan Stanley.

Thomas Quinlan III

Good morning.

Unidentified Analyst

Hi, good morning. Question for you on the covenant compliance for the revolver, I think it's a four times leverage test. Can you tell us where you are currently levered today with respect to that tax and are you allowed to add back restructuring another charges when you calculate the EBITDA?

Thomas Quinlan III

Yeah, it's EBITDA less cash restructuring as the EBITDA figure.

Unidentified Analyst

Okay. And do you have what your currently levered based on the calculations for that covenant?

Miles McHugh

I think calculated it's 2.5. We're around 2.5 numbers. I mean look there is no concern on our part as we said you today to tell you that we're in violation of any financial agreements or that we will be in violation of any of our covenants on the credit agreement. So we felt strong like that I think if you look at our industry which obviously you do, you've probably seen a number of players that have had a come out and make changes to there credit agreement whether operationally based or financed based we are not in that ballpark at all.

If anything, we're investing in this business. I mean some of the things that you've seen us announce recently ... hopefully don't get lost on anybody but the announcements that we've made from the technology standpoint, we're pretty excited about. We know what drives this engine we know it ranges from, what I call, that close tonnage print web to one to electronics but we've also going ahead and have the ability to make some pretty good announcements from a technology standpoint from the S-13 to Apollo and again we are very quietly sort of in the middle of what everybody has going on between our customers and all the other, what I call, device players there.

We're in the middle of all of that and which is great place to be. We've got an opportunity to invest in that. We've got an opportunity to change the evolution of print with these people and we're taking the advantage of that. So, I mean we currently do, now we do one to one books, one of books, that is always so exciting out there for everybody to see.

We work in the financial field, we work in the healthcare field, with the technology that helps to meet those two verticals more efficient. So, again we're, there is lot of things going on that R.R. Donnelley is participating in, may be you are seeing a lot of with our call probably head wind revenue tension that were in the mid stuff. And you have there is some more good fund things to come out at down the road where you'll see us make more announcements in you'll see us being with some people that you would not normally think you to see R.R. Donnelley would.

So, I mean I think those things, as you look at us and you think about the industry and you think about, okay, people worried about, are they going to be able to make payroll, people are worried about are they going to violate covenants. We're sitting here today as Donnelley has done for 145 plus years trying to see we're looking to see how we're going to evolve this industry, how is going to change, how we're going to help our customers, market to their customers in a more efficient manner. No one else, now one else has that ability, no one else is taking, gone along the lines to do those things. So, again we're passionate about it and we're having fun with it.

Unidentified Analyst

Okay. Thank you for that. And then, another one on the working capital, how should we pickup of the cash collection based for the rest of the year clearly significant improvement can you continue to improve on the days or should we think just kind be flat for the rest of 2009?

Thomas Quinlan III

I would tell you I think to add onto what Miles said. Cash as you've heard from my comments cash is a main driver of what we're looking at this year. It always should be but again we are emphasizing at this year, we are incenting people on the cash side so everybody's the visibility to what we're doing on cash is paramount. At the same time our customers are experiencing what they are experiencing which is obviously having some difficulties.

So, we've got to work together with them in certain cases and in other cases obviously we can not act as a bank either to go ahead and fund things. The great thing for us, is we've got customers that have great content and at the end of the day, if you got could content I don't care what mode of medium you want to go ahead and explore or work in, people are going to want that, people are going to pay for that and again we're fortunate enough to have people that have good content.

Operator we've got time for one more question.

Operator

Okay. So your next question comes from the line of Antoine Anquest (ph) with York Capital.

Unidentified Analyst

Taking the question as Antoine has asked (ph). Just a clarification really, when you talk about target leverage in the 2 to 2.5 times, given that you're sitting at about half a turn of cash Pro Forma for the $400 million notes reduction, is that a net target or a gross target and I have a quick follow up?

Miles McHugh

Yeah, that would be just a gross target.

Unidentified Analyst

A gross target.

Miles McHugh

Yes.

Unidentified Analyst

So...

Miles McHugh

It will be debt over EBITDA.

Thomas Quinlan III

Might as well kick into that calculation.

Unidentified Analyst

Understood. And then given that your run rate leverage on the growth basis is closer to mid 3s right now. When you talked about leverage going north of the high-end of that target range in the economic downturn, how far you're comfortable with going before, you think the agencies get concerned or before you start that aggressively paying down debt to try and get below that?

Miles McHugh

On a trailing 12, if you adjust for the payment of the $400 million that we've reduced that on April 1st on a trailing 12, we're certainly south of 3 going to be closer to the 2.5, 2.6 range.

Unidentified Analyst

Yeah, I was just analyzing that 29A of Q1 EBITDA.

Thomas Quinlan III

Yeah, we're saying that's the low point for the year. So, to do that what indicate there, what we said here this morning wasn't the case.

Miles McHugh

Yes, we have seasonality in the business and all the other things we mentioned.

Unidentified Analyst

Right, so in terms of your comfort level, if you are getting to the mid 3s or you still okay there or...

Miles McHugh

I don't see, I think is the question for me is sort of ended lot of pairing (ph) we're not looking. Right now, as we see the business come through, we think the rings that we've given and which is probably first time we view in a range publicly is a range that we feel comfortable with, right particularly with the cash that we've generated and with the guidance that we've given.

Unidentified Analyst

And have the rating agencies giving you guys any impetus through their comfort level?

Miles McHugh

(Multiple Speakers) announced the pretty well publicly how they feel about us and I think their documents speaks for itself and I wouldn't want to put myself in their shoes and speak for them. So I think if you take a look at that I think you will be able to see where they stand with us.

Unidentified Analyst

Fair enough. Thanks so much for answering the questions.

Thomas Quinlan III

Operator, let's take one more.

Operator

And sir, your next question is a follow up from Craig Huber with Barclays Capital.

Thomas Quinlan III

Hey Craig.

Craig Huber - Barclays Capital

Hey. One last question guys in relation with the 2004 (inaudible) long time. Looking at your company's 10-Ks back in 2001, 2002 you were adjusting back then. Your revenues were down about 10% back to back years I think was up 1% in 2003, FAS announce, sure you agree the economy seems to be a heck of a lot worse this time around than back then and with the digital transformation or mortgage places playing more severe now than back then. Given that you started off unfortunately down to 18% on the top-line, why would this year not be down meaningfully worse year-over-year you saw back at 01, 02 on the top-line?

Miles McHugh

I would tell you Donnelley back in '01 and '02 did not have the products and services that the scale that currently exist with the platform that was built in 2004, 2005. Donnelley had again I'm speaking, I was not here but let's call they had maybe a couple of 100 customers back then. Donnelley today has 40,000 plus customers worldwide. Donnelley today has close to probably two dozen products and services again that did not exist back then. I would also tell you that without a doubt Craig, the economic period that everybody agrees this is more severe recessions slash at some point as you know people are talking about depression than what occurred in 2000, 2001.

So, I think it's tough to compare the two-time period. I think it's very, very tough to compare what this entity, what this beast is today compared to what it was back then. And I think we've got ability to go ahead and help our customers, to that they mean that's the thing that I think we'd love to see that wasn't here before and if you go back and come back to the three areas that how we built this thing, how it plays out, you've got branding and advertising, okay, that's obviously taking hit right now.

You've got the business model, you've got your book publishers which again, in order for them to get paid they've got to go ahead and print, if they don't then obviously they've got revenue that's not going to come into take risk.

And then from a compliance standpoint, we've got compliance issues that are still whether it's in financial print area or whether it's statement printing area, those things have to take place and are continue to take place. That was not the case, if you go back to R. R. Donnelley back in the FY05. I think those things you take on to account compliance in healthcare, the BPO business that we have overseas, all those things are facts as we fell. Okay, they are going to be here throughout this.

The benefit for us again where else can we save our customers' money make them more efficient through their ROI and we get to marketing, branding and get to the core business products, so catalogues, magazines, books, all of those, again, are things where we think we've added great capabilities to this platform than that existed a decade ago.

Craig Huber - Barclays Capital

Great, thank you both.

Thomas Quinlan III

Thank you. Operator, thank you very much, appreciated. But it's time. Have a good day.

Operator

Thank you. This concludes today's conference. You may now disconnect.

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Source: R.R. Donnelley & Sons Q1 2009 Earnings Call Transcript

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