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

Q4 2011 Earnings Call

February 22, 2012 10:00 am ET

Executives

Dave Gardella - Vice President of Investor Relations

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

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

Analysts

Scott Wipperman - Goldman Sachs Group Inc., Research Division

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

Hale Holden

Bryan Keith Carlson - Atlantic Investment Management, Inc.

Thomas Cubeta - UBS Investment Bank, Research Division

Operator

Welcome to the RR Donnelley Fourth Quarter 2011 Results Conference Call. My name is Sandra, and I'll 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 Mr. Dave Gardella. Mr. Gardella, you may begin.

Dave Gardella

Thank you, Sandra. Good morning, everyone, and thank you for joining us for RR Donnelley's fourth quarter and full year 2011 results 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 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 provides 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'll refer on this call.

We're 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. As you know, in mid-January, we updated our full year guidance as we saw that our results would reflect a significant increase in cash flow as compared with our previous guidance. For the full year, our operating cash flow was up more than 25% as compared with 2010, and we delivered free cash flow of $695 million. That was at the high end of the revised guidance that we provided in mid-January. While full year revenue for 2011 was up nearly $600 million or almost 6% from 2010, we indicated in our January guidance that we had seen a slowing of revenue momentum during the closing weeks of last year. We also indicated that we saw some margin compression which was primarily a result of the volume declines that we saw during the latter months of the quarter. The change in our expectations regarding revenues during the fourth quarter arose particularly as a result of 2 factors. First, during the quarter, some customers deferred or canceled anticipated activity as they sought to impact their own end-of-the-year expenditures. This was not a surprise directionally but the number and volume of the programs that they pulled back on was significantly more than we had forecast. It was, in fact, a fast-moving departure from what the customers themselves had indicated that they were going to do during the last half of the fourth quarter. Second, the ongoing discrepancy between the number of filings and the number of IPOs priced continued to create an inventory of IPOs that are waiting to move forward. During the fourth quarter, this significant backlog grew even more and it affected revenues associated with our offering that supports capital markets activity. Despite these challenges, we were very pleased with our free cash flow performance. It reflected the operational controls and focus on working capital that we had baked into every aspect of our business.

Before Dan takes you through the fourth quarter in detail, I am going to reiterate our strategy and then add color to each of the strategic elements. The pillars of our strategy are as follows: One, we will share -- we will win share by aggressively pursuing all appropriate print opportunities across a diverse range of vertical segments and by using the comprehensive range of our integrated offering as a key value-added differentiator; two, we leverage our unmatched operating expertise, procurement scale and customer relationships; three, we build on our relationships with customers internationally to sell more services that can diversify and increase our revenue base; four, we internally develop and acquire technologies that serve important communication and supply chain needs for our customers and that continue to diversify our product and service mix as we serve a growing portion of our customers' communication and supply chain needs; and finally, we drive free cash flow and margin through continuing aggressive cost compression. With regard to winning share, there's still a lot of printing business to be had. We are competing for every opportunity. We've talked about our One RR Donnelley approach which positions us to efficiently present the full range of our capabilities to our customers. To make that happen from an organizational standpoint, we have knocked down all sales silos and incented our sales team to sell the full breadth of our offering; consolidated our infrastructure to provide for integrated solutions, productions and transactions; created a global print management solution and taken it enterprise-wide to both customers and prospects; and leverage the capabilities that have come from our recent technology acquisitions, which provide our customers with the integrated communication options that they need and that further differentiates us from our competitors.

One RR Donnelley is not only reflected in how we approach our customers, but also in the nature of the unique offers that we approach with them with. We have taken RR Donnelley from offering individual one-off product sets to providing bundled services, to transforming the deal structure itself to include the full array of our global print management resources. You're seeing this reflected in agreements we're winning such as the contracts we were recently awarded in the U.S. by Chrysler, IMG and Office Depot; and in Canada by Metro, the grocery and pharmacy chain. Accordingly, the deal structure has evolved with these bundled offerings, and we find ourselves benefiting from the economies of our scale and not needing to compete on a one product basis. We have also taken the lead in recognizing that there is a fundamental shift, not only in the mix of what customers buy, but in what motivates their decision about how to award the business. Winning share takes a different set of capabilities that are not merely product-focused. They must involve the breadth of the supply chain and requires scale to deliver value in each part of it. For example, the printed book sector, which is just one of the many verticals that we serve, has experienced a secular decline in demand. We are, however, best positioned to retaining gross share. When we take our integrated offering to publishers, it includes the ability to produce books on demand using our own ProteusJet digital inkjet presses; to draw on our international platform to offer cost advantages; to provide an integrated book fulfillment and distribution solution; to deliver printed books in response to spikes in demand so that the publisher can take maximum advantage of a title whose sell-through suddenly accelerates; and finally, through our LibreDigital acquisition, to take a single file and convert it for digital distribution on all of the popular e-reader devices. Nobody else can bring that portfolio of capabilities to a book publisher and no one else can do so with the kind of scale that we bring to customers. That is just one example and just one category of what One RR Donnelley is about. We offer similar difference-making capabilities across the full range of our product offering and across the broadest range of vertical segments.

The second element that supports our strategy is to leverage our unmatched operating expertise, procurement scale and customer relationships. RR Donnelley has built a well-deserved reputation for producing exceptional products, but we are also world class in providing a growing roster of service capabilities. RR Donnelley generates more than $1 billion of service revenue today. This constitutes revenue from logistics, Web and mobile site design, supply chain management, BPO, multiple channel marketing and more, and we're going to continue to focusing on diversifying our revenue base.

In November, we opened a new operation in central China, in Chengdu, which is the heart of the emerging high-tech operations center for global customers. This new facility is focused on supply chain management, including packaging. It involves new printed products for devices that didn't exist just a few years ago. This facility and new capabilities that we've added to facilities in Hungary and Mexico all serve as part of the expanding global packaging and label network. During the last months of the year, we completed 2 domestic acquisitions that centered around the product, packaging, labeling, merchandising and point-of-purchase displays. Retailers, consumers packaged good companies, health and beauty product companies, pharma companies, technology companies and many, many others use printed packaging products as key elements in their communications programs. In all of these instances, we are drawing on our unmatched expertise in operational production and process management. We will continue to look to grow our capabilities in such areas.

The third element that supports our strategy is to build on our relationship with customers internationally to sell more services that diversify our revenue base. As I said, RR Donnelley generates more than $1 billion of service revenue today. We have added and integrated entirely new digital service offerings such as Helium, Press+, Nimblefish, 8touches and more. We are and will continue be the best in the world at delivering services like these, which deliver exceptional standalone value and complement the balance of our product and service offering.

The fourth element involves continuing to internally develop and acquire technologies that serve important needs for our customers. Again, these technologies were added to the diversity of our expansive product and service offering.

We've talked before about some of the technology acquisitions that we have made, and I am not going to revisit those now, instead let me share just one example of how we are integrating these resources to create unique value-added solutions for customers. We were just awarded a new piece of business from a Fortune 100 financial services organization. For this company, we'll be executing a multitouch, multichannel series of campaigns that drawn on some of these enhanced capabilities that we have acquired. These will help us to serve this customer over our relevant communications, plus we'll be using our own MediaCompass digital asset repository and our own pivot system that integrates printed and electronic communication vehicle. So where some suppliers may have approached this customer and asked to bid on direct-mail printing, we approached the customer with a solution that utilizes 3 pre-proprietary RR Donnelley technology platforms. What we'll be executing is a series of printed, email and online communications that become progressively smarter and more relevant as data and content flow back and forth between us and the recipients. This is data-driven integrated marketing at its core. No one can offer this level of marketing communication sophistication under one roof, except for RR Donnelley.

This quick example illustrates that fourth pillar of our strategic vision, developing and acquiring new technologies in order to create new integrated selling opportunities. It may be that the innovations that most transform content creation and communication will be those surrounding big data. The massive database is being created by online purchases, mobile commerce and even the ability to follow the physical movement of mobile devices. It is out of big data that marketers will be targeting their communications programs. Through our founding relationship with a leading research institute, with ties to the MIT media lab and other enhanced data analytic resources, RR Donnelley will be right in the middle as these new concepts are monetized. The investments that we have already made in areas ranging from printed electronics to content creation are helping us lay the groundwork to further transform our revenue mix. The elements of our strategy are closely integrated, so being able to bundle these technologies with our conventional offerings help us win more legacy printing business and move us into brand-new service segments as well.

The fifth element that supports our strategy, one that is ingrained in everyone at RR Donnelley, involves aggressively matching cost to anticipated revenues. A lot of the sectors in which we compete are undergoing fundamental changes. In response, we have made and will continue to make tough decisions in order to ensure that our cost structure remains synchronized with our revenue opportunities in each segment. We are also taking steps to make as much of our cost base as possible variable so that cost takeouts can buffer slowdowns in economic activity, while our platform remains sufficiently flexible, so that we can move quickly to capitalize on upticks in any segment. Again, at RR Donnelley, financial discipline and watching cost is not a newfound concept. This is something we do each and every day. And with that, I will turn it over to Dan.

Daniel N. Leib

Thanks, Tom. As Tom mentioned, we ended 2011 consistent with the revised guidance we provided in mid-January. Operating cash flow less capital expenditures of $695.4 million, near the top end of the range, improved 33% from 2010. Full year 2011 revenue was $10.6 billion, an increase of 5.9% over 2010. Non-GAAP operating margin of 6.7% was at the top end of our revised guidance. And on a non-GAAP basis, EPS of $1.82 per share was $0.06 better than full year 2010.

For the fourth quarter, revenue of $2.7 billion increased 0.5% or $13.7 million from the fourth quarter of 2010 primarily as a result of the Bowne acquisition. On a pro forma basis, adjusting for the impact of acquisitions, revenue declined 3.7% in the quarter, primarily due to volume declines in our financial, book and directory and variable print offerings, partially offset by volume growth in BPO, logistics and office products. Pricing pressure remained consistent with historical levels. As Tom mentioned, the stagnant capital markets environment continued to negatively impact our top line, a continuation of what we saw in our third quarter results. Additionally, unfavorable changes in foreign exchange rates accounted for $20.6 million or 76 basis points of the year-over-year 3.7% decline in revenue. The change in pass-through paper sales was insignificant in the quarter.

There were several items impacting comparability of our fourth quarter GAAP results. Our GAAP loss from operations in the quarter was $317.1 million compared to income of $85.7 million in the fourth quarter of 2010. The fourth quarter of 2011 included $483.9 million of net charges for impairment, restructuring, acquisition-related contingent compensation and acquisition expenses, as well as a curtailment gain on our frozen pension plans, noncash impairment charges of $488.5 million in the quarter and were the result of our annual impairment testing. Comparatively, the fourth quarter of 2010 included $88.6 million of impairment, restructuring and acquisition expenses. All of these items had been excluded from our non-GAAP results, and I will discuss in -- that I will discuss in detail but a full reconciliation of our GAAP to non-GAAP results is included in our earnings release.

Fourth quarter non-GAAP operating income of $166.8 million was $7.5 million lower than the fourth quarter of 2010, and operating margin of 6.1% was 30 basis points lower than the fourth quarter of 2010. Lower volume in financial and book and directory as well as an unfavorable work mix, primarily within financial and most of our International segment and continued pricing pressure, more than offset improved productivity, lower variable compensation expense and a reduction in our bad debt provision.

On a full year basis, non-GAAP operating margins decreased 55 basis points to 6.7%. On a like-for-like basis, including the Bowne acquisition for the full year of 2010, non-GAAP operating margin declined 28 basis points, primarily due to unfavorable changes in product mix. Changes in foreign exchange rates did not have a material impact on the quarter-over-quarter margin comparison but had an unfavorable impact of approximately 14 basis points on the full year operating margin. Throughout the year, we made progress in reducing SG&A expense. On a like-for-like basis, full year SG&A as a percent of revenue was down 35 basis points from 2010 with the fourth quarter showing the most improvement, down 130 basis points versus the fourth quarter of 2010. Gross margin was negatively impacted by mix of business and pass-through revenue. We ended the year down 83 basis points compared to the prior year on a like-for-like basis. We continue to derive a greater portion of our revenue from products and services that we outsource on behalf of our customers. While this service offering is very capital-efficient, it pressures margins as the profit margin on this work is much lower than our company average. Over time, however, a portion of this outsourced work will transition to our own platform, and as such, the margins on this work will improve. To give a sense of magnitude, in 2011, we increased our outsourcing revenue in our International segment with certain customers by $87 million over 2010. This decreased consolidated EBITDA margins by approximately 10 basis points for the full year. Revenue from this offering is reflected in our BPO Global Turnkey Solutions and European offerings. Our non-GAAP effective tax rate in the quarter was 18.8% compared to 10% in the fourth quarter of 2010. The fourth quarter of 2010 included a significant release of valuation allowances on deferred tax assets that did not recur in the fourth quarter of 2011.

From a segment perspective, revenue in our U.S. Print and Related Services segment of $2 billion declined by 1% from the fourth quarter last year. Pro forma for acquisitions, revenue in this segment declined by 5.1% as volume growth in logistics, office products and commercial print was more than offset by declines across the remaining offerings. Additionally, pricing pressure across most offerings contributed to the revenue decline. Non-GAAP operating margin for the U.S. print segment of 8.9% dropped 70 basis points from the fourth quarter of 2010 as an unfavorable product mix, volume declines and continued price erosion more than offset ongoing productivity and lower variable compensation expense.

Fourth quarter 2011 revenue in our International segment of $715.7 million grew 4.9% versus the fourth quarter of 2010. Pro forma for acquisitions, revenue growth was 0.5%, inclusive of an unfavorable impact from changes in foreign exchange rates of 289 basis points. Volume growth in BPO Global Turnkey in Latin America, as well as increased pass-through paper sales in Europe, more than offset lower volume in Europe, Canada and our financial offerings in Asia. Pricing pressure in this segment was in line with historical trends. Non-GAAP operating margin for this segment declined to 6.2% from 8% in the fourth quarter of 2010. The margin decline was caused by an unfavorable product mix in part due to the outsourcing-related revenue I noted earlier, which had an unfavorable impact on EBITDA margin of more than 32 basis points, continued pricing pressure across the segment and wage and other inflation, primarily in Latin America, partially offset by lower variable compensation expense and ongoing productivity efforts.

Our fourth quarter 2011 non-GAAP unallocated corporate expenses were $55.5 million, a decline of $18.2 million from the fourth quarter of 2010. The improvement was driven by a lower bad debt provision, primarily due to a write-off of a customer receivable in the fourth quarter of 2010 and a reduction in variable compensation expense which was only partially offset by higher benefits-related expenses. As we mentioned earlier, we are very pleased with our cash flow performance for the year and especially in the fourth quarter. As I noted, full year operating -- full year cash flow from operations less CapEx was $695.4 million. Operating cash flow in the fourth quarter was $474.5 million, over $200 million better than the fourth quarter of 2010, driven primarily by our targeted working capital initiatives, as well as lower cash restructuring payments. Recall that in the fourth quarter of 2010, we made substantial payments on actions related to the Bowne acquisition. Controllable working capital as a percent of sales declined to 13.3% in the fourth quarter, an improvement of more than 130 basis points versus the fourth quarter of 2010. While our efforts to aggressively manage working capital positively impacted the 2011 performance in the back half of the year, we expect this rate to be sustainable and have opportunities to improve the rate longer-term.

Our capital expenditures in the fourth quarter of 2011 were $57.1 million, $27.4 million lower than the fourth quarter of 2010. Our full year capital expenditures were $250.9 million or 2.4% of revenue. Total debt as of December 31, 2011, was $3.7 billion, a reduction of $279 million from the end of the third quarter of 2011. Our leverage ratio at the end of the fourth quarter was 2.9x, within our targeted range of 2.5x to 3x and reduced from 3.1x at the end of the third quarter. As of December 31, 2011, our term debt is 81% fixed at an average interest rate of approximately 7.25%, and we had net available liquidity of $1.8 billion. Our liquidity is supported by our $1.75 billion unsecured committed credit facility that expires in mid-December 2013. And at year end, we had a drawn balance of $65 million.

Following our January 2012 maturity of $159 million that was paid off under the facility, our next scheduled term debt maturity does not occur until April 2014. As we begin this year, I want to share with you some of our expectations for 2012 which are based on an economic environment that is consistent with what we experienced in 2011. We expect revenue to be approximately flat to slightly increasing over 2011, excluding any impact of changes in foreign exchange rates. We expect our non-GAAP operating margin to be in the range of 6.8% to 7%, an increase of 10 to 30 basis points over 2011. Included in this range are corporate expenses of approximately $200 million to $220 million. Depreciation and amortization expense is expected to be approximately $515 million. Interest expense is estimated to be in the range of $240 million to $245 million. Our full year non-GAAP tax rate is expected to be in the range of 28% to 32%. We project the full year fully diluted weighted average share count to be approximately 183 million shares. Given the guidance on the items I just covered and consistent with what we noted in this morning's earnings release, we expect non-GAAP earnings per diluted share to be in the range of $1.84 to $1.92. Finally, we expect operating cash flow less CapEx of at least $500 million, which includes anticipated CapEx in the range of $200 million to $225 million. For the sake of clarity, I should note that this cash flow guidance includes the elevated level of contributions to our pension and postretirement plans. While we are not providing guidance specific to any of the quarters, I want to highlight that unlike 2011, we expect 2012 to be more in line with historical seasonality. That is, we expect the operating earnings to be more heavily weighted towards the back half of the year.

And before I turn it back to Tom, I'd like to share our perspective on capital deployment. In May of last year, we communicated our target capital structure of 2.5 to 3x leverage. Based on our view of the reduced capital expenditure requirements in the business, the M&A environment and the economic outlook, we announced that our Board of Directors had authorized a $1 billion share repurchase and that we would enter into an accelerated share repurchase program for $500 million. We completed the ASR in mid-November, and as I mentioned, finished 2011 with a leverage ratio of 2.9x. And while our pension obligation is not factored into our 2.5x to 3x leverage target or metric, it influences our thinking on cash requirements and the potential impact it has on our financial flexibility. With governmental intervention that has pushed long-term interest rates significantly lower than historical levels and with the current expectation that rates will be low for an extended period of time, our pension plan underfunding, on an accounting basis, increased to $1.1 billion at the end of 2011. While we froze and closed our pension plan effective January 1, 2012, and replaced the benefit with a defined contribution plan, we expect to have elevated cash payments for a few years, with 2012 being the highest level. In 2012, we expect pension and postretirement payments, inclusive of the 401(k) match, to be $254 million, an increase of nearly $200 million versus 2011 on a pretax basis. From a P&L perspective, pension expense will be reduced in 2012 compared to 2011, but the incremental expense related to the 401(k) match and restoration of the variable compensation opportunity nearly offset the reduction in pension expense. As we contemplate future share repurchases and M&A, our leverage target of 2.5x to 3x provides guardrails under which we make such decisions. We have not repurchased additional shares following completion of the ASR in mid-November. So from a capital priority perspective, we intend to fund our $1.04 per share annual dividend and pay down debt to remain within our targeted range. Although we view the stock to be very attractive at the current valuation and associate a dividend yield, we do not intend to go outside our targeted leverage range to repurchase shares. And with that, I will turn it back to Tom.

Thomas J. Quinlan

Thank you, Dan. Before we open it up for Q&A, let me just add some color to Dan's closing remarks regarding capital deployment. The continuing low interest rate environment has resulted in increased pension liabilities and required cash contributions, as Dan said. Given this environment, the secular challenges and certain product offerings as well as the abrupt changes in short-term demand that we experienced in the latter part of the fourth quarter, we believe it is in the best interest of all of our stakeholders, stockholders and bondholders alike, to focus on reducing debt levels and moving our leverage below the upper end of our targeted range. And with that, operator, let's open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question is from Charles Strauzer from CJS Securities.

Daniel N. Leib

Let me start it off and again thank you for making it clear that the guidance that we did give today does not require the economy to do anything more than what it did in 2011 for us to get to the targets that we're looking at in 2012. We as a management team, I think, we've proven to all of you that we get ahead of the storms that are brewing. We know we always have to maintain the lowest cost platform in the content distribution business, I'll come back to that in a second. But in 2011, given the timing of the year when it happened, it was tough for us to come back and do that. We talked earlier in the prepared remarks about what happened in the last half of the fourth quarter, which was our customers simply just canceled events. We've talked a lot about since 2008 how customers are operating more efficiently than ever before. I mean, the speed of play at which customers are impacting their own P&L is just instantaneous. As you know, we used to, in our industry, lag going into an economic downturn and lag coming out of it in better economic times. That's not the case anymore. So when we saw this and decided to place all our emphasis towards the end of the year on cash and we didn't borrow from 2012 to get for 2011, so that, that -- you shouldn't be sitting here and thinking that, that's going to be an issue for us. What we hope it did was it demonstrated to everyone that the operational control and focus we have baked into every aspect of the business is working. I made the decision, given the original guidance that we gave with on cash, which we greatly exceeded, obviously, and given what we were seeing happening to our customers, to pre-release on January 16. Obviously, the reaction that came back was not one that I, in particular, had expected. Given the fourth quarter earning releases that have been announced to date, I feel like we've been validated to some extent. The earning releases have been a mixed bag at best, so we are a good barometer for what's going on in the economy. Given all that, for 2012, the good news, if the economy continues to struggle, we know that our customers are going to continue to be laser-like on their cost. RR Donnelley has the lowest cost platform that allows us to help our customers reduce their total overall costs and with the technology capabilities that we added to the platform in 2010 and 2011, we're going to be able to further improve their return on their investment. I know we've demonstrated from a cost standpoint to you that we can take out cost, but the other thing too is you've got to maintain flexibility, which again I think we do better than anybody else in the business, and it's key. What do I mean by flexibility? Through nine months of 2011, we were growing the top line from an organic standpoint. So we know that this platform can grow as it sits today. We are not going to get into the circle of being forced to consolidate facilities. Our consolidation efforts are going to be strategic, they're not going to be forced. So we're going to preserve the capacity we believe we need to compete for businesses, customers' work. They might be 1 year or 2 years out. There's good work that's still going to be out there that we want to make sure that we can get onto our platform. Finding the right balance is the key as we go ahead and approach 2012. We believe we have a platform that can deliver for our customers, generate positive earnings and no matter what the economy does, we're prepared for it whether it's good or bad.

Daniel N. Leib

Yes, it's more a function of the latter, that we expect easier comps obviously, with what we saw in Q4. January is always tough to gauge. January is one of the smaller months in the year. So tough to gauge that as any sort of continuation but clearly, the comps get easier towards the back half.

Thomas J. Quinlan

Yes.

Daniel N. Leib

Yes, that's pension and our 401(k) match.

Daniel N. Leib

Yes, it's pretty speculative. I would tell you that degree of magnitude, so we're up roughly the 200 or so in this year, and that's a pretax number. Heading out to '13, '14, '15, it drops off roughly half of that increase. Again, somewhat speculative.

Thomas J. Quinlan

And, Dan, right now, I think as you and others know on the phone, that legislation is down in D.C. because, obviously, companies like our who are trying to do the right thing and have been around for a while, with defined benefit plans, due to what Operation Twist did, clearly had an impact on reducing the discount rates, and they've indicated that they're looking at a prolonged era of low interest rates. So there's talk of extending the amortization period from 8 to 15 years, changing the discount rates, all those things are out there. We haven't baked any of that into our numbers given, obviously, the uncertainty that takes place down in D.C. but it's good to hear them talking about it. I would also add onto that if you think -- I mean, just to roll into the decision that we made from a capital deployment standpoint to buy back $1 billion worth of our stock, we continue to look at many different scenarios that were out there that could take place. Having the Fed come back and take down the long end of the yield curve, shame on me, wasn't one of them. But that action forced us to close our pension plan, freeze and close it and to go back to a more, a 401(k) match for our employees in the United States. But given that, we're still looking at having our leverage target being 2.5 to 3x as guardrails. As Dan said, we haven't purchased -- repurchased any additional shares since the completion of the ASR in mid-November and as we've indicated here a couple of times now, we do not see ourselves going outside those guardrails.

Operator

The next question is from Scott Wipperman from Goldman Sachs.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Just a few points of clarification. One, I guess, Dan, can you break out the different parts of the $254 million, what's actual pension and what's actual 401(k) contribution?

Daniel N. Leib

Yes, sure. The pension side of it is about $215 million or so, and then you've got a small piece for OPEB and then the 401(k) is in that $30 million to $35 million range.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Okay. And then the comments on paying down debt and wanting to get -- bring the leverage target down, I mean, can you give us a sense of where you would be comfortable and is it 2.7x, 2.8, is there a target that we should be thinking about?

Thomas J. Quinlan

No, I think -- look, we're going to try to -- we're within that range, we're going to try to get down quite frankly, as low as we possibly can. Go back -- it would be -- a good point I can point you to is go back to 2009. We paid down $800 million of debt that year, and that was a year where everyone thought the world was going to end. And we knew that we needed to go ahead and do that to maintain the flexibility for the business. I think again, as we've operated with you since 2004, we've gone ahead and demonstrated that the way we allocate, deploy capital is that we make sure that it gives us the flexibility to continue to run the business and serve customers in the best way that we possibly can. And with what we're seeing out there on the horizon right now, this is the proper thing to do. The great thing about what we've done, from the standpoint of adding on the technology capabilities, is we've changed the name of the game as it relates to content creation, content enhancement, content management, content distribution, and, obviously, the key word I'm telling you here is content. Print continues to be an extremely effective way for organizations to organize and share content, but we know it's not the only way, and those capabilities that we added on in '10 and '11 are really, really going to help us from the standpoint of what deal structures are going to look like, we are going to -- deal structures within our industry are going to change. Conversations are not about the price of a direct mail campaign, as I've talked about before. They're now about campaign management and these conversations have taken place with our customers in off sites, in places like Cambridge, Massachusetts and in Silicon Valley. So you're seeing RR Donnelley appear in places where you wouldn't normally think about seeing us. We want to be the infrastructure for content for the Fortune 1000, and we are doing it and, I think, it's evidenced by some of the contracts that we recently announced with Chrysler and IMG.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Sure. That's helpful. And then just to be clear on the buyback, you still have the authorization through 2012. So in theory, I mean, if things get better, you could still be buying back stock in the second half of the year, just to be clear.

Thomas J. Quinlan

Yes. If things -- look, those are the guardrails, as we've talked about, as we see the economy right now. Look, as I sit here from my economic look that I see this is going to be another choppy year where goodness knows what happens if gas prices go to $5, what is that going to impact, how is that going to impact our customers, what is the disposable income in the United States is going to be. Europe has their own issues as we know. China is trying to continue their great growth rates. Latin America in certain parts are doing well, certain parts aren't. We participate in all of those global economies. I think the way we've structured our cost structure for 2012 gives us the confidence to come back here to tell you that we're going to at least have $500 million of cash, and we're also going to be in the range of EPS that we talked about. That's not something that we've gone back and talked to you about over the last couple of years, but given the actions that we're taking, given what we see, what our sales force is able to do, we feel comfortable at this time of the year coming out and telling you this.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

All right. And then sort just 2 more quick ones. As you think about -- I mean, I appreciate all the comments you've given on capital allocation but is it still that your guys' view and lets put this year aside, but longer-term from an M&A perspective, that there's nothing out there of size that you think can help the business? I guess, I'm thinking of areas outside of traditional print, something like services or digital. I mean is it still the Board's and your view that with M&A, you're still not going to be on the larger side of things?

Thomas J. Quinlan

Well, let me start off and give you the real live example of Bowne. I mean, we went ahead and did Bowne. I've always talked to you about customer cost and capacity as far as what we look at. Bowne gave us the ability not only with customer and cost takeout and capacity, but gave us employees and capabilities from a technology standpoint that we didn't have before. Everyone sees what's going on with the financial markets, and you know that they come and they go, but if anybody thought we did that deal just for financial print, transactional compliance, they were mistaken. We received phenomenal customer relationships. These are relationships with CEOs, CFOs, General Counsels. The former Bowne employees didn't have the RR Donnelley platform to sell to their customers, now they do. The former Bowne only had financial print to offer. Now as part of RR Donnelley, there's 15-plus products and services to offer. RR Donnelley has now, has access to these new customers, and the engagement with these new customers is at the most senior level of our customers' organization. The technology that we got with XPRL and virtual data rooms combined with the technology that we had. These technologies are transferable across all industry verticals. So when you look at that particular property that we sent, 2011 wasn't a great year as everyone knows from a capital market standpoint, but we're so well positioned in that space right now that when the market does come back and eventually it will, we'll be able to go ahead and with the scale that we've captured in 2011 -- the share that we captured in 2011, and this is all public data that you can look at regarding the IPOs, and I welcome you to do it. It positions us well to go ahead and go to the next avenue, next space. Are there other properties like that, that are out there? Look, we made the decision in May of 2011 not to go ahead, and there wasn't those properties out there, no, we said we were going to deploy our capital towards shares. As I sit here almost a year later, do I see that changing? No. So, I mean, I think we're, with the acquisitions, the investments in technology that we've made, those things will pay huge dividends as we continue to go to the market and with a great service offering for our customers to help their business.

Operator

The next question is from Dan Leben from Robert W. Baird.

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

Just first, when we're thinking about the guidance looking more like historical levels, is there anything that you've seen in January or February to date that makes us think that the falloff in the fourth quarter was anything you can recapture or something where we could get growth rates back closer to flat or do we really need to play catch up in the second half?

Daniel N. Leib

Yes, I think, to my previous comments, January, very small, small sample size, but we don't see anything specific to the comment of being more in the historical seasonality other than the fact that the back half of '11 was weaker, so you're entering a period of easier comps.

Thomas J. Quinlan

And look, let's again not want to give a history lesson but go back, RR Donnelley in 2000 had -- 2/3 of its revenue were driven by domestic magazines, catalogs, retail inserts and books and directories. 2011, these products, from a domestic standpoint, constitute less than 1/3 of our revenue. So I mean, we're still one of the largest and best players in those products, which we know some of them are challenged, but we've done a great job in diversifying our revenue base with the same customers. So given what we've got to offer, we think, from a customer standpoint, historically, a presidential election, Olympics, European football championships. When they all take place in the same year, everybody has content that they want to distribute. Usually that's been good. We're not, as we sit here today in February, is there any signs of that right now? No. But again as I talked about, I think, you're going to have a year where you're going to have ups and downs throughout a month. What people are going to want to spend, what data is going to be out there that's saying, "Okay, I want to go out and get -- talk to my customers." $5 a gallon of gas in the United States is not going to be a good thing for anybody. So if that takes place, what is that going to mean from an economic standpoint? You better have your costs in line and you better be able to know that your platform that you've got can withstand that and I think we can.

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

Okay. Just shifting to the cost side, if you could walk us through what happened to the gross margin line on a sequential basis. I know you talked about the outsourcing but just looking fourth quarter versus third quarter, a little over 150 basis point sequential drop on a higher revenue base, help us understand what the changes were and what's kind of permanent versus what we could expect to see reverse as we go through 2012?

Daniel N. Leib

Yes, I think probably what will be helpful is we're filing the K today and when you look at the mix of product lines, that will probably give you some help, and some of it is natural seasonality of what's larger in Q4 normally. So I think, the moniker it falls under is mix, but, I think, when you look at the relative product mix that will really explain it for you.

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

Any previews you can give us before the K comes out?

Daniel N. Leib

Yes. I mean, I think we could run through the basis points, but I think the reality of it is, is that when you see the product line mixes and that will all be public later this afternoon, that's going to be the helpful time to have the discussion.

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

Okay, great. And then 2 more for me real quick. First, on the pension specifically to the P&L cost, could you talk about kind of pension only, what the difference in costs are for 2011 versus 2012?

Daniel N. Leib

Yes. So when we're looking at '11 versus '12, roughly 95 to 100 and then you're going to offset that with 401(k) and then you're going to offset that with replenishment of plant level and other incentive plans.

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

Okay. And then last one. Just in the free cash flow guidance. Given the weak fourth quarter this year and looking for a much stronger fourth quarter next year, is there working capital, use of cash that you've got built in there, or just help us understand that assumption.

Daniel N. Leib

Yes, sure. So tremendous progress as we mentioned. We talked earlier in 2011 about a -- some shift coming in working capital due to the Bowne acquisition and what we typically see in our financial business of the use of cash in the first half of the year and releasing cash into the back half. That exists, that's of now a permanent part of our structure. I would tell you that when we put the full court press on mid-year and really began the initiatives, began building process and systems around the initiatives, our expectation heading into '12 is that working capital is relatively flattish from a generation of cash, so it will be driven by the revenue line. So the volume will be the driver rather than the rate. As we look at it, relative to opportunity to take that number down further, we do believe there's opportunity, but want to have some level of conservativeness in the forward view.

Operator

The next question is from Hale Holden from Barclays Capital.

Hale Holden

Just 2 quick ones, just a clarification on the $500 million cash guidance that's after paying the pension expense?

Daniel N. Leib

Yes, correct.

Thomas J. Quinlan

Please, anybody -- just stay there for a second. That's after paying the pension expense. So I want everybody to understand that because this company since 2004 we've averaged about $600 million of free cash flow that we've been able to generate. Obviously, we almost did $700 million in 2011 from the initiatives that we took with -- from a working capital standpoint. Again, I'm telling you we didn't borrow from '12 for '11. We're down to $500 million, primarily as a result of the additional cash that's required under the pension plan payment.

Hale Holden

Perfect. And then I think there's a lot of concern or maybe misinformation in the market about the books and the directories line as it relates to maybe Apple education push and how quickly that moves to e-books and how you're positioned there. So any color you could give us on how we should think about that line over the next year, whether it stays stable, whether it declines, whether over the next 5 years it becomes just the less meaningful part of the business, would be helpful.

Thomas J. Quinlan

No. I'll start up and Dan can jump in. We had a conversation the other day here saying, "Who can name the top 5 #1 sellers on the New York Times bookselling list in 2011?" It's tough. 2011 was not a great year for content. Forget everything else you've heard about the book market, it wasn't a great year for content that took place. Add on top of that, the deficits that the states have in the United States, those are impacting adoptions in the educational -- in education. We all know that Borders going out took a big hit in the industry. And the electronic devices that are coming out every day, look, these are great. People are experimenting, people are trying, people -- that's got an impact to it. With all that said, we still believe that we can be the single source solution for an integrated manufacturing fulfillment and service capability for our customers. The properties that we've acquired and the proprietary equipment that we have, from doing print on demand, digital print, brings great value to the customers. Are we expecting that the states, the Californias, Floridas, Texas and New Yorks, from talking to our customers, are going to have big adoption this year? No. So that's not based into -- as you look at our numbers, that's not out there. Is it possible for 2013? Yes, we think that they are, from talking to our customers, obviously, who are, obviously, a part of this as well, this is not -- textbooks, as they sit today, are not going away. The President and the FCC Chairman, obviously, came out last month and talked about how -- or earlier this month I should say, talked about how they want the whole country to be Wi-Fi-ed so that textbooks could be electronic. That is a great goal to set. It's not going to happen in the next 5 to 6 years. Again, why? Can we get kids school supplies that they need, will houses be Wi-Fi-ed throughout the country? We're each paying a charge on our telephone bill now so that we can help make that happen. That's a long ways off. So the need for textbooks is still going to be there for a period of time, and we're going to participate in that when it comes back to be there.

From a content standpoint, look, I think is there another Twilight series out there? Is there another Harry Potter that's out there, who knows. But, I think, at some point, there will be something like that. But I really look at content as being the driver for what's taken place in the book market. When you think about what we added with LibreDigital, LibreDigital basically allows you to take files in from our customers and we can get it to whatever device you want to get it to. So again it comes down to about content and how is RR Donnelley playing along the digital supply chain, digital logistics, physical logistics. You could have all the content in the world, it could be intelligent, engaging, compelling, but unless it reaches the right person, at the right time, through the right channel, it's not going to matter, and we've been able to go ahead and build a platform that has those capabilities for our customers. So long-winded way of telling you, look, it's not -- the book market, as we talk about '12, we are not expecting the book market to have -- come roaring back, primarily due to the fact that we think that deficits that exist in the United States are going to make K through 12 education, new adoptions for the states, difficult to go ahead and obtain.

Operator

The next question is from Bryan Carlson from Atlantic Investment.

Bryan Keith Carlson - Atlantic Investment Management, Inc.

I just wanted to ask about a couple of revenue-related items. So you said that revenue guidance would be flat to up slightly, that excludes FX. What is your anticipation if rates stay at these levels for FX impact for 2012?

Daniel N. Leib

Yes. The expectation would be as we saw through '11, top line impact was positive through 3 quarters and then it was negative in Q4. You would expect it to continue to be negative heading into '12. We have had the dynamic where less of a drag on the earnings side.

Bryan Keith Carlson - Atlantic Investment Management, Inc.

So the expectation would be a modest headwind for at least the first half of the year and then no impact on the margin line or [indiscernible] negative impact?

Daniel N. Leib

Yes, there's a slight margin impact to it, but, yes, there's the -- that is the expectation on the top line.

Bryan Keith Carlson - Atlantic Investment Management, Inc.

Okay. And then can you just talk a little bit about your expectation, I mean, you've just spoken about books and directories not coming back but can you talk to your expectations about some of the other major end markets? And specifically, can you tell us is it your expectation that the backlog of IPOs would finally come out? Is that sort of a recovery in that financial print, is that anticipated at some point, is that anticipated in your guidance during 2012?

Thomas J. Quinlan

Yes. Let me go back talk to you about the IPO market. I think if you look, there are 97 IPOs priced in the first half of 2011, which was up 38% from the same period in 2010. Q3, only 23 priced versus 34 in 2010 third quarter. And Q4, it was down over 50%, only 31 priced versus 66. And obviously, as you know, we don't recognize revenue until the IPO is priced. The positive side with all this is our major S filings were up 10% in Q4 versus Q4 2010. So look, we've built a budget this year that is consistent with what we saw in 2011. So if that is there, then that's great news, but we're not banking on that taking place.

Bryan Keith Carlson - Atlantic Investment Management, Inc.

Okay. And then is it possible for you to speak to any of the other sort of major movers from Q4? So variable or any of the other end markets?

Thomas J. Quinlan

Let me go about it in a different way for you to see to -- as far as how we're approaching our customers, as far as how we're going to try to service them. I mean, we've started -- John Paloian and Dan Knotts, we started a global print management with George Zengo. We're looking to derive significant opportunity for organic growth from the Fortune 1000. I mentioned earlier, we want to be the infrastructure for the Fortune 1000. This process redefines our customer relationships. It creates long-term scale and converts transactional revenues, contractual relationships with stickiness. So no matter what's going on with any product that you want to talk to, if we're going ahead and servicing the customer the way we think, at the level we think, that's all going to get baked into what we're looking at. It improves our productivity and asset utilization across the entire platform. It then shifts from a product-focused selling to an enterprise -- from a product-focused selling to an enterprise-wide sales team and product specialist approach. So this is all good news for us. It's a couple of hundred billion dollar industry still, content is, as certain people define content. As we look at content, it's bigger, and I think that's where, as we wake up every day with our people, our sales force, our support functions, we look at this as being a pretty good world for which we can play in. We can capture the content, again if it's sourced, however that content is being done. And this could be labeled brochures that are taking place. We can be in the content creation, content enhancement, content management as I talked about earlier. This going to go ahead and bode well for us to go ahead and get that on our platform.

Bryan Keith Carlson - Atlantic Investment Management, Inc.

Okay. Just a last question on pricing. Obviously, as you try to go deeper into the customer and make the negotiation more enterprise-focused, necessarily it becomes less price focused as you suggested. All of that said, is it your expectation in the guidance that you would experience, I think, historically it's been modest. So low-single digits sort of price pressure, would you expect that going forward?

Daniel N. Leib

Yes. We've talked before, if you look at the pricing dynamic that we've had historically going back since we've been together since '04, 1% to 2% has been the range, and that's a consistent view that we've experienced in '11 and an expectation in '12.

Operator

The last question will be from Thomas Cubeta from UBS.

Thomas Cubeta - UBS Investment Bank, Research Division

I want to ask you about the -- your cash balance in the U.S. versus abroad, I want to get a sense of the timing on the pension payments. Will you need to draw on the revolver potentially to make those pension payments? And then looking ahead, what do you think you'll look to address the revolver and potentially extend it? And then finally, it sounds like you guys are going to be a little bit more conservative about using cash and buying back shares at least in the near-term. Have you had discussions with the ratings agencies and what's their take on that?

Daniel N. Leib

Sure. So cash balance-wise, end of December $450 million of cash, about 85% of that is outside the U.S., which consistent we keep a small amount of cash here since we're a net borrower, we paid down the revolver when we can, at the end of the year we had a balance of $65 million under the revolver. Related to pension, the heaviest quarter is going to be Q3 of the payment. The rest, there's not a big amount in the first quarter, a little bit more in Q2 and then Q3 is a big quarter. Related to rating agencies, yes, we've had a number of conversations with them throughout the year and updates relative to our guidance and relative to our results.

Thomas J. Quinlan

The White House, I think, as each of you have seen this morning, they've issued their blueprint for corporate tax reform. Obviously, we think that's going to impact the -- at some point, they'll have something in there regarding the repatriation of cash or what the international tax system is going to look like. We think, at the end of the day, that is also going to benefit us. It's, obviously, not something that we're counting on happening in 2012, but we think that is something down the road that will take place that will be okay. Credit facility doesn't expire until the end of '13, 2013. We've got good relationships with our banks, we continue to have conversations with them and we think we're in a good spot there as well.

Well, I appreciate everybody joining the call today. Hopefully it's been informative for you and we appreciate the support and look forward to talking to you throughout the year. Thank you very much.

Operator

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

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