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Executives

Thomas J. Quinlan - Chief Executive Officer, President and Director

Dave Gardella - Vice President of Investor Relations

Daniel N. Leib - Chief Financial Officer and Executive Vice President

Analysts

Charles Strauzer - CJS Securities, Inc.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

Edward J. Atorino - The Benchmark Company, LLC, Research Division

Craig A. Huber - Access 3:42, LLC

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Hale Holden - Barclays Capital

R.R. Donnelley & Sons (RRD) Q3 2011 Earnings Call November 2, 2011 10:00 AM ET

Operator

Welcome to the RR Donnelley Third Quarter 2011 Results Conference Call. My name is Monica, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Dave Gardella. Mr. Gardella, you may begin.

Dave Gardella

Thank you, Monica. Good morning, everyone, and thank you for joining us for RR Donnelley's Third Quarter 2011 Results Conference Call. Earlier this morning, we released our earnings report, a copy of which can be found in the Investors section of our website at rrdonnelley.com.

During the 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 that presentation of non-GAAP and pro forma results, provide you with useful supplementary information concerning the company's ongoing operations and is 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 also posted to our website, in the Investors section, a description as well as reconciliations of GAAP measures to which we will refer on this call.

We are joined this morning by Tom Quinlan, Dan Leib and Drew Coxhead. I'll now turn the call over to Tom.

Thomas J. Quinlan

Thank you, Dave, and good morning, everyone. During the third quarter, our employees responded to the challenging environment with a continuing commitment to operational excellence. As I have said before, because of our scale and the volumes that we deal in, ours is a business in which operational excellence is the key to our success. Each incremental improvement can produce significant results and our employees' efforts were reflected by $300 million of operating cash flow in the quarter. That is an increase of over $90 million from last year's third quarter.

Our continuing ability to generate cash flow even during times of economic uncertainty has allowed RR Donnelley to consistently return cash to stakeholders as evidenced by the $4.6 billion in payments we have made since we arrived in 2004, in the form of interest payments to bondholders and dividend and share repurchase to equity holders. Our ability to generate cash flow has also enabled us to reinvest in new solutions that broaden our capabilities, make us even more efficient and allow us to continue to prudently manage our capital structure.

Dan will shortly take you through our financial results in detail and then we will open it up for questions. But first, I will briefly address 4 topics: one, how we are positioned in the cyclical capital market segment; two, the results that we are seeing from our global print management strategy; three, how we are integrating new strategic initiatives while maximizing the value of our existing platform; and four, some achievements that characterize how customers continue to regard the value of our offering.

I'll begin with one of the hurdles that we confronted during the quarter. This was the dramatic slowdown in the fluidity of capital markets and particularly of IPOs being priced in August and September. This affected the results in our financial printing unit, where we serve capital markets and investment management clients globally. Market volatility has created a significant divergence between the number of IPOs filed and the number of IPOs which were actually priced. Unlike 2008 and early 2009, our service centers were busy during the quarter as companies prepared to access the financial markets and continued with their pre-issuance filings. The backlog is a timing difference in when the IPOs will be priced in the market and we do not recognize the revenue for this work until the deal is priced. It's difficult to predict when this backlog will move, but when it does, we remain exceptionally well positioned to take immediate advantage of it.

The second topic I'll discuss is our global print management initiative. This involves what we believe to be our unique ability to address customer needs across the broadest range of requirements and the broadest span of locations. It's global in both senses of the word. We continue to have success with regard to print, but we're also getting more opportunities because of our ability to deliver end-to-end solutions that feature our digital multi-platform communications capabilities. We are building on to the world's best end-to-end print-related platform by layering it with a range of digital resources that are extremely attractive to our customers and prospects.

Let me give you an example of how this is being received. A couple of weeks ago, we announced a multiyear $550 million agreement with AMI, American Media. We will be providing a range of services to AMI, including pre-media, magazine print production, variable digital print production, TransPromo, communications, logistics. We'll be exercising our international resources to support AMI, and we'll be drawing on the resources of our new CustomPoint Solutions Group, which we introduced to you last quarter. In the new multimedia environment, publishers, marketers, retailers and others are 360-degree communicators. They want to be in each medium. We can take them there.

In an interview with Folio, AMI's vice president of production talked about broadening the availability of its content to more digital venues and said the digital assets RR Donnelley is bringing to the table is through its CustomPoint Solutions Group. They are the group that's going to be working on our digital convergence. As these comments and more important as this agreement illustrates, our customers see what we already do for them in taking digital content that we have provided for print and repurposing it for a digital distribution as a natural efficient extension of our services. Our ability to enable 360-degree communications as a single source service provider reduces cycle time, eliminates costly handoffs and streamlines complex processes.

As a second example, let me share a ground-level case of how our capabilities are being integrated into multichannel communications. A leading specialty retailer has customers who are in the age bracket between 18 and 22 years old, always on a mobile device and live on social media. We help this retailer put together a comprehensive promotion that use commercial printing, label production, large format digital printing, kitting fulfillment logistics and sourcing management. The program was designed to draw the targeted consumers into the retailer's website and to continue to build this database of information about them. In a matter of just weeks, these young adults uploaded to the retailer's website 780,000 pictures of themselves interacting with the piece we produced, and they had voluntarily SMS texted 156,000 complete permission marketing profiles to the retailer. Creating integrated solutions that work with a demographic that is not thought to be receptive to print is helping us keep pace with the fast changing environment.

The importance of our global print management strategy is also reflected in the activity of our self-service print management CustomPoint platform, which saw a 12.7% increase in ordering activity during the third quarter as compared with the same quarter a year ago. Customers self entered more than 566,000 orders during the quarter, reaching into our highly automated print fulfillment and distribution network.

We are also seeing this effect internationally. For example, during the quarter, our revenues in Latin America were up by more than 31%. This was driven in part by higher commercial print volumes in Argentina and Mexico and increased sales of books and education testing materials in Brazil. We're not the only company that produces educational testing materials in Brazil, but our distinct global print management competencies drive opportunities onto our platform. In this instance, it's our ability to provide data and physical security related to processing production and distribution.

Our global print management strategy is also driving continuing growth in our service sector, which now comprises about 12% of RR Donnelley's revenues. For example, our logistics revenues were up more than 17% as compared with the same quarter in 2010. For the first 9 months, logistics revenues are up 16.9% as compared to the same period a year ago. Our scale and our national and international logistics capabilities have never been more important to our customers. Again, it is combining sophisticated services like these with our other offerings that help us deliver unique advantages to our customers. Across the board, we are seeing our global print management strategy working to expand and extend existing relationships and to win new opportunities.

The third topic I'll address is how we are integrating new strategic initiatives while maximizing the value of our existing platform. During the quarter, RR Donnelley completed 3 acquisitions: Sequence Personal, which offers capabilities to aggregate content that can be brought to life through digital printing to create fresh advertising revenues and promotional values for our customers. LibreDigital extends our presence in the content supply chain. It is a leading provider of digital content distribution, e-reading software, content conversion, data analytics and business intelligent services to book, magazine and newspaper publishers as well as to e-reader device providers. The next time you walk down the aisle on a train or an airplane and you observe someone holding books, magazine or e-readers, in each case, there is a very good chance that they are holding our work in their hands. Genesis Packaging & Design is a full-service provider of packaging, point-of-purchase signage and other displays used by manufacturers, retailers, publishers and a wide range of other customers. The products that Genesis produces play an increasing important role in our customer marketing mixes. That's because the explosion of media option and product extensions have driven more consumer decision-making to the in-store experience. People used to write down the name of their favorite brand of toothpaste on their shopping list. Now one brand alone has more than 40 varieties of toothpaste available. That makes the products we offer for in-store and other front-line marketing venues even more crucial, plus the products in the space are particularly resistant to electronic substitution. It's important to note that we did not enter into the segment that Genesis serves cold. We have been sourcing through our global print management relationships, millions of dollars of this kind of work, for our customers. So we were able to load that volume onto the Genesis platform, making this acquisition an immediate success.

These acquisitions come on the heels of several others, which we have expanded the range of capabilities that we offer. Our expectation is that these new resources will work for us in 2 ways: First, as individual offerings, they'll deliver growth potential as we integrate and ramp them up. Second, as illustrated in the AMI example I discussed earlier, these CustomPoint solutions and other capabilities will enable us to win much larger deals as part of a bundled offering. We are continuing to push the envelope at RR Donnelley and customers are seeing us as a resource in ways that they haven't before. That will continue.

Earlier, I mentioned that we help the customer gather permission-based data about consumers in one of the most desired demographics. Accurate data of this kind is emerging as an entirely new asset class, immensely valuable to marketers. As one of the largest content distributors in the world, we are positioning ourselves to take advantage of the opportunities that are going to arise in this space. There's more to come on our expanding efforts in this arena in the very near future. We will continue to be the best in the world at what we do today, and we're working to become the first in the world to deliver what our customers are going to need tomorrow.

Finally, before I hand it off to Dan, I want to quickly highlight 2 achievements. During the quarter, our office products reporting unit drove revenues up by 8.5% versus the same quarter a year ago. This is a solid result in a competitive space. Our office products professionals' work was also recognized during the quarter as we were named Staples' Supply Chain Vendor of the Year. If you take a look at the lineup of suppliers in Staples' online and brick-and-mortar stores, you'll see that this distinction put our office products offering at the head of a very impressive class.

We were also recognized during the quarter by IKEA's Tulip Award as one of the best -- as the best print supplier. IKEA cited in particular our holistic approach in finding optimal production and logistics solutions. The annual IKEA catalog is synonymous with the IKEA brand. Our innovative approach to delivering spot-on quality and the important ability to maximize postal discounts for IKEA, are great illustrations of the way in which our integrated solutions create significant value for our customers.

Ultimately, whether our work is showing up on electronic device or in print, we have to delight our customers. These are just 2 quick examples of how RR Donnelley's employees are working to do that every day.

And with that, I will turn it over to Dan.

Daniel N. Leib

Thank you, Tom. In the challenging economic environment, we are pleased with the many aspects of our third quarter results. Operating cash flow in the quarter was $303.7 million, an increase of over $90 million for the same quarter a year ago. GAAP operating income grew over 5%, and earnings per share more than tripled from the third quarter of last year, driven by the recognition of a $77.4 million noncash tax benefit. On a non-GAAP basis, EPS increased over 15%, also impacted by a favorable tax rate.

Our third quarter sales of $2.7 billion represented an increase of $195.2 million or 7.8% over the third quarter of 2010, primarily as a result of the Bowne acquisition. On a pro forma basis, adjusting for the impact of acquisitions, revenue increased by approximately $40 million or 1.5%. Favorable changes in foreign exchange rates and increased paper sales accounted for $27 million and $24 million of the revenue growth, respectively. Increased volume in our Latin America, commercial print and logistics offerings, as well as the favorable impacts from foreign exchange rates and pass-through paper sales more than offset lower volume in books and directories and financial print, which was impacted by the slowdown in capital market's activity. The pricing environment remained consistent with historical levels and our expectations.

Third quarter GAAP to income from operations was $156.8 million compared to $148.7 million in the third quarter of last year. The improvement was driven by lower impairment and acquisition-related charges, which collectively declined almost $20 million year-over-year. A full reconciliation of our GAAP to non-GAAP earnings is included in our earnings release. Third quarter non-GAAP operating income of $191.7 million was $8.3 million lower than the third quarter of 2010.

Third quarter operating margin was 7.1%, 90 basis points lower than the same period last year. Lower volume in books and directories and an unfavorable mix of work within financial print, as well as continued pricing pressure more than offset improved productivity, lower variable compensation, expense and a higher recovery on print-related by-products. On a like-for-like basis, adjusting for the acquisition of Bowne, which had a historically lower margin, our non-GAAP operating margin declined approximately 15 basis points. Unfavorable changes in foreign exchange rates and a higher pass-through paper sales unfavorably impacted margin by nearly 30 basis points.

Our non-GAAP effective tax rate in the quarter was 24.1% compared to 35.7% in the third quarter of 2010. Driving the decrease in the rate was the resolution of certain state tax matters.

Our U.S. Print and Related Services segment sales of $2 billion grew by 6.3% from the third quarter last year, primarily due to the acquisition of Bowne. On a pro forma basis, adjusting for acquisitions, U.S. sales declined by 0.4% or just under $10 million. Strong volume gains in commercial print, logistics and office products were more than offset by pricing pressure, continued volume declines in books and directories, as well as the impact that the slowdown in the capital markets had on our financial print offering that Tom mentioned earlier. With respect to the decline in books and directories, we noted on our second quarter conference call that we saw a shift from the second quarter to the third quarter on some of our education-related work, which did occur, but demand for one-color trade books continued to be weak in the quarter. Non-GAAP operating margin for the U.S. print segment remained flat at 10% as continued productivity and cost take-out efforts, lower variable compensation expense and a higher recovery of print-related by-products offset price erosion.

Third quarter 2011 sales in our International segment grew by 12.3% over 2010 to $703.9 million. Pro forma for acquisitions, revenue growth was 7.5% or $49 million, inclusive of a 4.1% favorable impact from changes in foreign exchange rates. Volume growth in Latin America and Asia, as well as increased pass-through paper sales in Europe more than offset lower volume in our financial print offering in Asia, Canada and Europe. The slowdown we experienced in the U.S. capital markets had a similar impact internationally. Non-GAAP operating margin for the segment declined to 5.9% from 8.5% in the third quarter of 2010. While changes in foreign exchange rates and increased pass-through paper sales benefited our top line, operating margin was negatively impacted by approximately 68 basis points. The balance of the margin decline is caused by continued pricing pressure across the segment and wage and other inflation primarily in Latin America, partially offset by lower variable compensation expense across the segment.

Our third quarter 2011 non-GAAP unallocated corporate expenses were $47 million, an increase of $7 million from the third quarter of 2010. The increase primarily reflects higher pension and other benefits-related expenses and an increase in information technology spending in part driven by recent acquisitions, partially offset by lower variable compensation expense.

As I mentioned earlier, operating cash flow in the third quarter was $303.7 million, an improvement of nearly $92 million versus the third quarter last year. Our targeted actions resulted in a working capital improvement in the quarter of $109 million compared to the same quarter last year. On a year-to-date basis, operating cash flow is down $9 million as our working capital improvement and lower cash tax payments were more than offset by the $120 million year-over-year increase in cash payments for variable compensation in the first quarter this year.

Please recall that the variable compensation payments in the first quarter of 2010 represented only a portion of the aggregate payment for the 2009 plan year as the plan in that year prescribed a pro rata payout over 4 years. The 2011 payment included the full amount related to the 2010 plan year, plus the second installment of the 2009 plan year.

Our leverage ratio at the end of the third quarter was 3.1x, slightly lower than the 3.2x at the end of the second quarter but above our targeted range of 2.5 to 3x. That was driven in part by our $500 million accelerated share repurchase program that we began in May of this year. We funded the full $500 million in May, retiring 80% of this year's upfront at a share price of $20.06. Our settlement price is a negotiated price relative to the weighted average trading price over the entire trading period. As of October 31, the average weighted price was $17.18, so we will receive additional shares upon settlement, which we expect to occur in the fourth quarter.

As we continue to generate free cash flow and reflect the full year with Bowne results, we expect our leverage to continue to decline in the fourth quarter and anticipate being at less than 3x at year end. Going forward, we continue to target a range of 2.5 to 3x leverage on a sustainable basis, recognizing that at times, we will operate outside of this range.

This morning, we are also announcing the closure and freezing of our United States defined benefit pension program. The volatility of market returns and interest rates over the past few years has increased significantly the volatility of funding requirements in these plans. This means that effective December 31, 2011, no new participants will enter into the pension plans and that benefit's accruals will be frozen at the levels participants have earned through December 31, 2011. In joining the majority of companies that have moved from a defined benefit plan to a defined contribution plan, we will be reinitiating our 401(k) company match at an enhanced level. While the pension funding numbers are not finalized yet, we expect our overall cash funding requirement associated with these plans to increase in 2012. We will communicate the required funding on our fourth quarter results conference call in February.

On September 28, 2011, we repurchased an additional $11.6 million of the 11 and 3/4 senior notes due February 2019 with excess cash on hand. As of September 30, 2011, our term debt is 75% fixed at an average interest rate of 7.2%, with our next term maturity due in the first quarter of 2012 in the amount of $159 million. In addition, we had $345 million drawn on our $1.75 billion committed unsecured revolving credit facility that matures in December of 2013. At the end of the third quarter, we had $1.3 billion of available liquidity, as detailed on Page 14 of our earnings release.

We believe our capital structure will be supported by our ongoing ability to generate substantial cash flow and will continue to provide an appropriate level of liquidity to continue to invest in the business through both CapEx and acquisitions to help fund future growth. We do not foresee the need for significant increases in CapEx or larger M&A given stronger growth expectations in the service base and digital print offerings and the relative investment dynamics associated with each.

Before I turn the call back to Tom, I want to provide our updated guidance for the full year. We expect year-over-year revenue to be in the range of $10.7 billion to $10.8 billion. At the midpoint of this guidance, this implies pro forma growth of approximately 1.5% in the fourth quarter, consistent with our third quarter pro forma revenue growth. We expect our non-GAAP operating margin to be in the range of 6.8% to 7%. This range implies a fourth quarter margin of approximately 6.7% to 6.8% or 30 to 40 basis points higher than last year's fourth quarter.

Included in our full year assumptions are SG&A expenses of approximately $1.25 billion and total corporate expenses of approximately $240 million. We continue to make progress on reducing SG&A. In the third quarter SG&A as a percentage of sales was approximately 60 basis points higher than the third quarter of 2010, largely driven by the Bowne acquisition, which historically carried a higher level of SG&A. On a like-for-like basis, however, SG&A as a percentage of sales was favorable by 30 basis points compared to the third quarter of last year. On a year-to-date basis, the same metric is essentially flat to last year, so the cost savings are improving and we expect this favorable trend to continue.

Similarly, compared to the fourth quarter of 2010, total corporate expenses are expected to be down 16% year-over-year. Depreciation and amortization expense is expected to be approximately $560 million. Interest expense is still estimated to be in the range of $245 million to $250 million. Our full year non-GAAP tax rate is now expected to be in the range of 25% to 26%. We expect income attributable to noncontrolling interest to be in the range of $1 million to $3 million. We assume the full year fully diluted weighted average share count to be approximately 198 million shares. Please note that this estimate is the weighted average for the full year, taking into account only a partial year of the accelerated share repurchase program implemented in May. Giving full effect to the accelerated share repurchase program, we expect our year end fully diluted share count to be approximately 180 million to 185 million shares.

Full year capital expenditures are expected to be in the range of $250 million to $275 million. And lastly, we continue to expect operating cash flow less CapEx of approximately $600 million. As I mentioned earlier, our third quarter cash flow was particularly strong and we bring this momentum into the fourth quarter.

Before I turn the call back to Tom, I should note that as a result of the pension plan freeze, we expect a noncash curtailment gain of approximately $40 million to be recognized in the fourth quarter of 2011. This curtailment gain is not reflected in our operational guidance.

And with that, I will turn the call back to Tom.

Thomas J. Quinlan

Thank you, Dan. Two quick comments before we open it up for questions. First, another independent director has joined the RR Donnelley board. In addition to his experience in corporate governance, Rick Crandall brings a broad technology-related background to this role. Welcome, Rick. We look forward to working with you.

Second, I'll touch on just one example of our continuing strides in the most important measure of our operational excellence at RR Donnelley. That's safety. Another one of our sites, this one in Ireland, has been recommended for ISO 18001 certification, which reflects a rigorous and systematic approach to health and safety. We see safety as highly correlated to quality and other key performance metrics.

And with that, operator, we'll turn it over to you for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Charles Strauzer of CJS Securities.

Charles Strauzer - CJS Securities, Inc.

So Tom, a couple of quick questions. If you could maybe elaborate kind of when you look at some of the comments you had about kind of the rest of the year, what kind of your thoughts. And even into next year really, what are your thoughts in terms of kind of like your economic assumptions as you kind of build that out?

Thomas J. Quinlan

Sure, Charlie. I think if you would have told me -- if I would answer that at the beginning of the year, I think very few people, if any, envisioned at the beginning of the year that the United States government would be downgraded as it was this past August and the impact that, that had or that -- I think we all thought at the beginning of '11 that GDP would be somewhere between 2% and 4% growth, but it's turning out to probably be closer to flat for 2011. The European debt crisis was going to further impact the global economy or that the United States government would basically shut itself down this year. But, I mean, given all those challenges that we faced in this environment, I think we've been executing very, very solidly. We've got stable top line performance. We've still got strict cost discipline in place, and we've got a dividend that continues to endure. As this generator of free cash flow, our leverage is still manageable. We've got significant debt maturities that we -- that do not occur until 2014. And obviously, we've got cash that's sitting overseas there. We've got to continue to be an innovator, operate efficiently and be agile as we continue to scale this platform. And we're doing that and more. I think our continued to have a shift -- or some reducing our customers' total cost of ownership and increase our customers' return on their investment is taking place. So the infrastructure that we built here with the one RR Donnelley is -- there's collaboration which is valued and rewarded. And as result of that, we're seeing opportunities that we haven't seen before. We're having conversations with customers about work that we haven't had before. We're doing contracts that are unique. Because of the service and capabilities we have, we're in a much healthier place that we're in right now compared to where some others are compared to where this industry used to be. So again, I think as we look to close out this year, we still got tremendous ability in this quarter to help companies reduce their total cost of ownership and to help those companies have a return on their investment of what they've got going on. The 2 things that impacted us in the quarter, without a doubt, was the capital markets. I think everyone on the phone has realized that the IPO market has basically shut down. And when you think about what the President's council on jobs and competitiveness, what they came out with last week, urging key regulatory changes to reduce cost so that companies that are at that $50 million to $100 million revenue level can come out and do IPOs. They're looking at regulatory changes from everything from Section 404 rules to some of the SEC rules regarding fair disclosure. So that is something as we're sitting here, saying, "Okay. If that does come back in the fourth quarter, that will be helpful to us." At some point in time, there is going to have to be capital raising taking place in the marketplace. And as Dan and I both indicated to you, we're in a good spot when that takes place. And obviously, that is good margin work for us.

Charles Strauzer - CJS Securities, Inc.

And then, Tom, talking a little bit about the textbook cycle. Obviously, there's been a lot of delays and pushback there. What are you hearing there and what are you kind of assuming kind of into Q4 and into next year for textbooks?

Thomas J. Quinlan

The budget deficit that the states have in the United States are definitely impacting adoptions, but brick-and-mortar sales channels took a big hit, as you know, what Brothers declared in Chapter 11. And believe it or not, there's a couple more electronic devices that are in consumers' hands from tablets to phones, so again, as you talk about what was at the beginning of the year compared to now. But with all that said, for those consumers that still want a single source solution, we offer an integrated manufacturing fulfillment service capability and we've got the properties that we have acquired and the proprietary equipment that we have. That's going to bring further value to customers. Print-on-demand in this area is going to continue to increase. And it will not only be for books, but it's going to be for magazines and catalogs as well on the long run side. And we, again, can do print runs from millions all the way down to print 101. Our goal here, Charlie, for this particular product line is to make the book supply chain more efficient. We've already started it by going ahead and taking over warehouses for customers. We want to continue to help book publishers know who their ultimate customer is that bought their product. That's something that doesn't exist in the marketplace today for most of them. We want book publishers to use their working capital in more productive ways, and we think we can be helpful there. And we want to get -- to have a book published and just get rid of obsolete inventory and have a better way to handle returns. Content is with us, we feel, is always going to be in stock and there is never going to be anything out of print if we're able to go ahead and impact the supply chain here as we think we will.

Daniel N. Leib

Yes. The only thing I'd add, Charlie, is Q4 is historically not a 4-color textbook quarter. And so there's usually some 1 color college work that goes on, but no expectation of 4 color work in Q4.

Charles Strauzer - CJS Securities, Inc.

Got it. And then lastly, Tom, just talking on the Postal Service. Obviously, the iterations of various goals that are being proposed in Congress. I think there was a Washington Post article saying that the compromise may be coming soon. What are you hearing there? What do you think the likely outcome is there?

Thomas J. Quinlan

There's another area in D.C. -- I think each one of us has seen for the last couple of years that there has been a lot going on there. I mean, the challenges confronting the USPS, they fall into 3 categories: financial, structure and innovation. All 3 are impacting its fiscal stability. If you think about it, the infrastructure was built to deliver 300 billion pieces annually. And I think right now, our numbers are showing that it's probably about $160 billion -- 160 billion pieces that are out there. In terms of innovation, the Postal Service is taking great steps over the last couple of years to execute new business initiatives, but they've had mixed results. I think as you look out today and I think 11:30 today, East Coast time, Senators Brown, Lieberman and -- excuse me, there's 2 -- Carper and Collins are going to come out with a bipartisan bill for the Senate to approve that's going to look to go ahead and reform and bring savings to the USPS. When you combine that with what the House did, with Darrell Issa and Steve Lynch from Massachusetts, we're going to get a bill out of this thing. I mean, I think for one thing that's going to take place in Washington in early 2012 is you're going to see that there will be a bill come out from both the House and the Senate. They're going to have to get together. They're not that far off. They both think -- in our minds, I should say, they're not that far off. They've got to address the financial situation as it relates to the CSRS and where does that -- does that get returned as far as the health benefits? Does it get returned to the USPS from a structural standpoint? We don't think -- our own opinion is it won't go from 6 to 5, but there will be less days that the Postal Service will deliver. I think the Senate, what they came -- or coming out with this show in 12 days would come out of the system. That may be a solution. I think Donahoe is doing -- he needed to shine a flashlight on what he's got going on and he's done that. And I think from an innovation and pricing standpoint, they've got to look at different ways of going there. With all that said, we continue to mitigate any cost increases in this area for our customers. We have to. We develop innovative strategies to help our customers roll their business. And it's paying dividends for us, as you can see, in what the logistics numbers that we announced for the first 9 months of this year, tremendous numbers. We're operating the most full co-mail production lines in the industry. We have -- our offer is unmatched distribution that includes co-mailing of standards, periodic and tablet products, co-pallet program that has the largest number of participants and the highest volume. From a standard letter-size mailers, we offer trade co-palletization. So we continue to make substantial investments in this area and we continue to see opportunities that will come out for us and our customers in this area. And I think the good long-winded answer short to good news is I do think we'll see some time in early 2012 that legislation coming out of D.C. in this area.

Operator

Our next question comes from Craig Huber of Access 342.

Craig A. Huber - Access 3:42, LLC

My first question is a housekeeping question. You mentioned, I guess, in your press release or prepared remarks, incentive compensation costs were down. Can you just give us what that number is, please, in the third quarter? What was the free to the first 2 quarters? I have a follow-up, too.

Daniel N. Leib

Sure. So first quarter compared to prior year was flat.

Craig A. Huber - Access 3:42, LLC

Yes. Can I have the numbers, please, as well?

Daniel N. Leib

Yes, sure. First quarter, $28.7 million, flat to 2010. Second quarter, $29 million, which was a decrease of about $15 million. Third quarter, $10.2 million, which was a decrease of about $24.6 million.

Craig A. Huber - Access 3:42, LLC

Okay. And then, Tom, as I typically liked to ask you, anything changed now there on the pricing pressure front? It's sort of down in that range of 1% to 3%.

Thomas J. Quinlan

Yes. And I think for the first time in a long time, I can come back to you with a little bit of a different answer here from what we've said to you in the past. I mean, that is -- in general terms, that is still where we're sitting at. In total, each product is different. But I will tell you the things that we talked about in the prepared remarks, as far as global print management goes, we're seeing different things taking place there. We're driving significant opportunity for organic growth, especially with the Fortune 1000. This is redefining our customer relationships. We're creating long term excuse me, scale and converts transactional revenue to contractual revenue with stickiness. And as a result of that, that's changing the pricing dynamics. I think as you've seen or will see in our Q, our transactional business had -- there were some changes in the margins there even though some of the other margins that we talked about obviously have been impacted. But it's improving our productivity and our asset utilization across operating platform and its evolving the sales organization and how we go to market. So as we look at it, we truly are excited about what we think the global print management effort is not only going to do for the platform but will do for us from a financial standpoint.

Craig A. Huber - Access 3:42, LLC

And then this margin goal you're talking about for the year or target 6.8% to 7% for the full year of 2011, I guess, versus 7.3% last year. Can you sort of give us a sense how much of that downward pressure there is from the Bowne acquisition and some other currency? Or perhaps, as you see things, what else is impacting that, please?

Daniel N. Leib

Yes, so as we -- our comments on the quarter and on a year-to-date basis, the Bowne acquisitions we gave a like-for-like number certainly has a negative impact. There's also a bit of a mix between gross margin and SG&A. Bowne is similar to our financial business with a heavier SG&A business. And so as we look at the full year -- and on top of that currency, which was, call it, negative 30 basis points or so. And so as you look at the Q4, that mix is what's driving the improvement in the margin relative to prior year. So it's a business mix that drives it positively.

Craig A. Huber - Access 3:42, LLC

How much for the full year is your ballpark of margin erosion that's just from the Bowne acquisition?

Daniel N. Leib

Yes. So the difference on a pro forma is about 10 basis points.

Craig A. Huber - Access 3:42, LLC

Okay. And then my last question, if I could. If I heard you right, I think you said you're not looking to do any sort of large acquisitions. Is that correct?

Thomas J. Quinlan

Craig, I think as Dan illustrated or talked about, our ratio -- leverage ratio being 2.5 to 3x, it is where we're comfortable with. I think if you look to see what we've done in the last couple of months and actually this year, the technology capabilities that we've added, some underneath the CustomPoint Solutions Group, some not, but, they're not thought about in a graphics industry as us going ahead and taking on such properties. But when you think about -- we already handle secure information and we receive digital content for the products that we routinely print, but as a provider of communication solutions, our customers have need for content. Helium provides that source of content. It can be used for creating publications, book, enhancing websites. More and more of our customers want their website to be the destination place for people, whether during the day or in the evening when they come home. And we're doing it in a cost-effective manner down to the individual level of that particular participant. When you think about monetizing content, Press+ does that. They offer subscription immediate solutions. As I said before, they help generate revenue from any electronic device. And light box provides targeted marketing messages based upon realtime online behavior. LibreDigital, the e-reading services, they serve book, they serve periodical distribution as well as B2C sales, which again is something that Donnelley hasn't participated in. Sequence personal has a system for creating custom publications. They can do that on the fly. They can distribute it electronically or support it by our expensive digital print network. And then when you think about Nimblefish, multichannel marketing and integrating direct response, customized video and pearls to enhance customer loyalty. All of these things here -- it would be a remiss by not mentioning 8touches that has the self-service online marketing templates. But our customers, whether they're the publishers, the Fortune 1000 companies or even the governments, they want their content to be sent to their end users in multichannels. They can't exist without having numerous suppliers. We're fitting that bill right now. So from an acquisition standpoint, you're probably going to see us do more of what you've seen us do along the digital supply chain as opposed to what we've done in the past when you think about properties that are in the graphics industry that we've normally have acquired as a team.

Operator

Our next question comes from Scott Wipperman of Goldman Sachs.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

You somewhat addressed this, but I guess I was just hoping to touch a little bit just more on capital allocation and specifically with the share buyback. I mean, I guess, what I'm wondering is, has your view changed on the benefit of share buybacks since initial announcement. I mean, obviously, the markets have been extremely volatile since May, but the stock is down. And so I guess I'm just wondering does this change how you think about this going forward because maybe a higher dividend make more sense or allocating more capital to the smaller M&A that you're speaking to, Tom. Any color you can provide there? And how you guys are thinking about the buyback in light of the current markets would be helpful.

Thomas J. Quinlan

Look, it's -- the action that we took at the beginning of this year is a capital structure action. And as we sit here today, everyone's obviously experiencing what's going on in the equity market. It's still a cash accretive transaction for us. As I talked about earlier, we continue to look to reward stakeholders in a prudent manner based on our capital structure. And when you think about what we've done since we've been together as a management team of $4.6 billion going back to the hands of the stakeholders in the form of interest payments, in the form of dividends, in the form of share repurchases, we're going to continue to manage that business that way. We think we've been -- we think it served us well. We survived 2009 without a lot of, what I call, wringing of the hands by us at all. We've continued to serve customers. So as we're looking forward, we're going to continue to monitor what's happening in the global economy because we're impacted by the global economy. And we're going to continue to see what's out there for us. So as I'd say, we'll come back to you in 2012 to say our start is going to be completed in the fourth quarter. And we'll come back and take a look to see what's going on around the world.

Operator

[Operator Instructions] Our next question comes from Dan Leben of Robert W. Baird & Co.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

First off, in terms of segments, you've hit on most of them but you haven't talked about mag/cat retail. What was the performance there in the quarter?

Thomas J. Quinlan

As Dan's going through that, I'll tell you we're very excited. We think everybody will probably show some good numbers this particular quarter there. But compared to year-over-year, not bad. And I think as you've seen in some of the announcements that we've made this year, that work doesn't start until 2012. So we're excited about what the future holds for that particular -- those particular products. And again, with all the new technology capabilities that we brought on, we're having completely different conversations with this particular group of customers for us. That is lowering their cost and improving return with their customers. So it's an exciting time to have the platform that we've got. We're having great meetings. We're meeting with knowledgeable experts from some of the world's leading higher universities. We're going to come out with something on that shortly. We're creating beta sites to explore some of the findings that we're learning. So the introduction of these new phones, tablets and other electronic devices that you would think, Dan, that would obviously impact these particular products, they're also creating new markets for us that didn't exist a couple of years ago and we're taking advantage of that.

Daniel N. Leib

Yes. Dan, just to put the numbers to it, magazine and catalog retail inserts in the quarter and we'll have all these when we file our Q. It was down 1.5%, which brings the year-to-date to down about 30 basis points.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

Okay, great. And then on the margin side, how much of the lower guidance as well as the performance in the quarter, how much of that is just kind of purely the low margin paper pass-through piece versus some of the challenges you've had in terms of mix?

Daniel N. Leib

Yes. So if you go to the consolidated EBIT margin, right? On a reported basis, it's down about 90 basis points. On a like-for-like -- so incorporating Bowne on a pro forma basis, it's down 15 basis points. And between FX and the impact of paper, that's about 28 basis points of negative impact. We've talked before about the incremental non-cash pension expense. It would impact it another 10 basis points or so. D&A has a small negative impact of about 10 basis points. And so the balance of it between the impact of price and the incentive offset to it and mix.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

Okay. And that's consistent with how you're thinking about guidance for the fourth quarter, similar type headwinds?

Daniel N. Leib

Yes. I think it's a consistent view. Clearly, we have a view of October and consistent view.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

Great. And then last one for me, just around the pension closing and freezing that, obviously, positive move there. Help us understand what that will do when we get to the end of the year in terms of the overall liability for pensions. Is there a benefit from no longer having the program running that could offset some of the year-over-year decline in rates?

Daniel N. Leib

Yes. Well, we won't know. That will be set at the end of the year based on discount rates. So clearly, discount rates have been running this year significantly lower as there's been some actions taken on the yield curve to bring that down in the future rates. And so that has anadverse impact on the obligation side. So we won't have a definitive number. At the end of last year, we were about $550 million underfunded. And we'll report that out when we report our fourth quarter. And similarly, on the funding side, we do expect an increase in 2012 funding and we'll have those numbers firmed up when we report our fourth quarter in February.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

And then the right range to think about that is -- if rates are down 100 basis points, it's about $500 million in additional underfunded liabilities. Is that right?

Daniel N. Leib

Yes, that's the right range. As I mentioned -- well, the curtailment gain, which is a -- just a noncash gain in the fourth quarter.

Thomas J. Quinlan

And, Dan, we've been looking at this obviously since fourth quarter of 2008 in, whatever you want to call it, recession, depression. But the movement by the Fed this past quarter, I mean, to drive down the long-term interest rates -- obviously, they're looking to help the economy, but at the same time, as each one of you know, it raises future pension costs dramatically. So we know we're one of the last Mohicans, so to say, with a pension plan, defined benefit plan as it was to our employees. We're going to go to a defined contribution plan for them. And again, it takes -- obviously, from your standpoint, it takes uncertainty out of the marketplace and we're going to proceed accordingly.

Daniel R. Leben - Robert W. Baird & Co. Incorporated, Research Division

Now does this change -- any additional liabilities or whatnot, does that change your view on the leverage side in terms of where you're comfortable? Do you take this into account? Or is this a separate issue? You paid out over 7 years and you kind of ignore it.

Thomas J. Quinlan

No, we take everything into account. And I think, obviously, this is factored into how we've looked, how Dan went through the numbers. I mean, we started, obviously, pulling the numbers together earlier on and factor those in our modeling as far as what we're looking at.

Operator

Our next question comes from Hale Holden of Barclays Capital.

Hale Holden - Barclays Capital

I just had 2 pretty quick ones. If you could just look out a couple of years and give us an idea of what percent of revenue we should be thinking about at books and directories fall through or goes to or stays out, I think it would be helpful. And then second, following up on Scott's question on the buyback, should we sort of assume that the second $500 million from ASR that was going to be done in 2012 is sort of somewhat economic dependent and you'll wait until the end of the year and then just decide where you go with that? Or is that -- the factor is going to be done in 2012?

Thomas J. Quinlan

Hale, I think the -- I'll take the -- I'll go on first. The answer is yes. And regarding the first one -- look, goodness only knows what a book directory catalog magazine, what form they're going to take place. As you think about going out a couple of years, if the United States could get to housing market back in good form as opposed to where it is now, that is going to create -- generate a tremendous amount of product for us both from an electronic distribution standpoint and a physical distribution standpoint. If the regulations that are in place -- Basel III that's out there right now -- for the banks to go ahead, that's going to constrain the marketplace if in fact the banks have to go ahead and raise 10.5% -- be at a 10.5% capital level. So take the economic conditions that are out there, couple them with how our industry and the products in our industry are changing, we're excited by it because we think we've got a great setup here with the service and capabilities that were brought on board here already and that we're bringing on board to go ahead and serve our customers where we're going to bring value towards them.

Operator

Our last question comes from Edward Atorino of Benchmark.

Edward J. Atorino - The Benchmark Company, LLC, Research Division

Most have been answered. But I'm just curious, any set of quad-color combination. They seem to be consolidating. Is that sort of loosening up some business over there for you?

Thomas J. Quinlan

Ed, as you know, we don't talk about people outside the family. So I mean, whatever they've got going on there -- but what I will tell you is again, I think we're helping customers develop, manage and distribute the content to target-engaged customers, enhance and differentiate their brand experience. We're building brand loyalty and we're driving growth. And this is done across technology immediate for print, web, mobile and social networks around the globe. No one else has that. No one else has that platform, and it's going to take them years and a heck of lot of money to try to build what we've built. Look, we will back here next year. Believe it or not, we're at that time of the year already. We hope everybody has a safe and healthy holidays, and we appreciate your support as always. So thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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