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

Q4 FY07 Earnings Call

February 27, 2008, 10:00 AM ET

Executives

Daniel Leib - Sr. VP, Treasurer

Thomas J. Quinlan III - President and CEO

Miles W. McHugh - EVP and CFO

Analysts

Matthew Troy - Citigroup

Charles Strauzer - CJS Securities

Piyush Sharma - Longbow Research

Karl Choi - Merrill Lynch & Co.

Edward Atorino - The Benchmark Company

Jake Kemeny - Morgan Stanley

Operator

Good morning. My name is Terri and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Full Year 2007 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.

I would now like to turn the conference over to Mr. Dan Leib. Sir you may begin.

Daniel Leib - Senior Vice President, Treasurer

Thank you Terri. Good morning and thank you for joining us for RR Donnelley's fourth quarter 2007 earnings conference call. Earlier this morning, we released our earnings report, a copy of which can be found in the Investors section of the website, at www.rrdonnelley.com.

During this call, we will refer to forward-looking statements that are subject to uncertainty. For a complete discussion, please refer to the cautionary statement included in our earnings release and further detailed in our Annual Report on Form 10-K and other filings with the SEC.

Further, we will discuss non-GAAP and pro forma financial information. We believe the presentation of non-GAAP and pro forma results provides you with useful supplementary information concerning the company's ongoing operations and are an appropriate way for you to evaluate the company's performance. They are however provided for informational purposes only. Please refer to the press release and related footnotes for GAAP information and a reconciliation of GAAP to non-GAAP information. We've also posted to our website in the Investors Presentations section, a description as well as reconciliation of non-GAAP measures to which we refer on this call. We are joined this morning by Tom Quinlan, Miles McHugh, Drew Coxhead and Sue Bettman.

I will now turn the call over to Tom.

Thomas J. Quinlan III - President and Chief Executive Officer

Thank you Dan. Good morning everyone. Before Miles takes you through our quarterly and full year results in detail, I will make some short introductory remarks and then briefly address four topics. First, actions that we are taking related to our business process outsourcing offering. Second, RR Donnelley's attractiveness to customers who are seeking creative solutions and longer-term relationships. Third, how today's announced addition of Pro Line Printing reflects our acquisition strategy. And fourth, what we're seeing so far during 2008 and our guidance for the year.

Prior to addressing these topics, let me provide a sense of context by taking you back for just a moment to the beginning of 2007. In about a three-week period during January, we completed the acquisitions of printers Banta and Perry Judd's and announced that we would acquire Von Hoffmann. These acquisitions involve integrating sales teams, multiple manufacturing, distribution and service sites, thousands of new employees, a variety of human resources policies and a number of different computer systems.

Last year, we told our owners and our customers that our employees were up to the challenge of managing this integration and of transitioning to a one RR Donnelley brand and operating strategy, without taking their eyes off the ball. As our results indicated, our people delivered.

For the full year 2007, revenue was up 24.4% and we achieved the promised non-GAAP operating margins of 10%. On a like-for like basis, giving effect to the lower margin businesses that we acquired in 2007, operating margins were up 85 basis points in 2007 compared to 2006.

We continued to generate strong cash flow, with cash from operations of nearly $1.2 billion, an increase of over 30% from the prior year. In the fourth quarter, non-GAAP earnings per diluted share from continuing operations were $0.80, up more than 14% from $0.70 in the fourth quarter of 2006. For the full year, non-GAAP earnings per diluted share from continuing operations were $2.94 a share, an increase of more than 15% from $2.55 in 2006.

In the quarter, pro forma organic revenue growth was 1.8%, against the same quarter a year ago and was 2.5% for the year. As Miles will describe more fully, these organic revenue growth rates reflect our intentional move towards filling our platform with the most profitable opportunities. To maximize profitability on the asset base, we focus on generating high utilization rates throughout the year. A strategy important to driving utilization is leveraging the full range of our capabilities to expand customer relationships. Accelerating this activity is particularly important as it relates to our first topic, actions that we are taking to address our business process outsourcing offering.

We took in the quarter, an approximately $460 million in non-cash impairment charge, predominantly related to the annual test of goodwill for our BPO business, comprised of the operations formally known as Astron and OfficeTiger that we acquired during the past three years. While we have made significant strides in learning how best to run this BPO business, the financial performance that was envisioned three years ago as these acquisitions were undertaken has not materialized nor met expectations. So, we are aggressively refocusing this offering on opportunities that are best fit for our existing resources. We are also in addition to working to new customers, taking more advantage of the existing print-based relationships, particularly in the financial services and legal sectors.

Showing the benefits of our broad platform brings me to our second topic, RR Donnelley's attractiveness to customers who are seeking creative solutions and longer-term relationships. Many customers and prospects are beginning or continuing vendor consolidation efforts. We are seeing customers look for innovative ways to group more of their purchases through a single vendor that can provide end-to-end solutions. We occupy unique space that is exceptionally well aligned with this trend. We have built an in-house platform that allows us to deliver the full value associated with a complete one stop-shop solution. We are not just a middleman trying to knit together pre-press, printing and logistics from a variety of different sources with different owners, different quality processes, different operating models, different computer systems and different priorities. We're one RR Donnelley.

Customers usually choose to enact these kinds of relationships through longer-term agreements. We are seeing that our financial strength, consistent performance and continuing ability to develop and offer new capabilities are significant points of competitive differentiation. Customers seeking a stable and growing partner are presenting us with fresh opportunities. The $800 million contract that the McGraw-Hill Company has just awarded to us puts an exclamation point on the importance of these factors.

Our momentum continues to be docked in a variety of other ways as well. For example, we continue to win third party recognition of RR Donnelley's quality. The prestigious New England Book Show recently recognized educational books produced in our Reynosa, Mexico facility. Our book platform offers customers U.S, Mexico and China-based facilities for the best mix of cycle time and cost. When demand spikes for a title or there is a specialty timely, our domestic operations enable publishers to rush a book into stores.

For example, we just printed, bound and shipped more than three million copies of the runaway number one New York Times paperback bestseller, A New Earth by Eckhart Tolle in less than two weeks. Helping the publisher Penguin Group, USA respond to the extraordinary demand generated when the book become the featured selection of a popular book club.

When a publisher schedule affords more cycle time, our Mexico and China platforms offer distinct cost advantages and consistently excellent quality. The value that we deliver was also illustrated during the quarter as Hachette Book Group USA, a leading U.S-trade publisher announced that it signed a multiyear agreement to have RR Donnelley produce its one color, hard-cover and soft-cover trade books. This agreement, which became effective in January, expanded RR Donnelley's global relationship with the second largest publisher in the world. One of the shorter run commercial print facilities was recognized during the quarter by the print industries of America as a regional printer of the year.

Our facilities were also recognized with premier print awards, known as Benny's. Our Fortune 1000 clients are careful to protect their brands. So they are extremely selective about where they place their commercial printing. Our quality coupled with our full range of services is extremely attractive to them.

Another set of scorecards that illustrate our momentum are the Wall Street Journal and Citibank's recap of M&A and IPO activity in 2007. Our global financial printing offering, which combines deal management expertise, digital printing resources and lightning quick composition services won fully two-thirds of the biggest worldwide deals in 2007. RR Donnelley handles 70% of the biggest U.S. IPOs and was awarded six of the top ten global M&A deals during the year.

During the quarter, one of our facilities located in Pontiac, Illinois demonstrated remarkable resilience in the face of a devastating flood that deeply affected our employees and the community. This disaster took the life of one of our valued employees in his own home, has he sought to address the damage. Others of our employees suffered significant property losses. However, our people in Pontiac came through for each other and for our customers. I and we, never take for granted the exceptional character and craftsmanship exhibited by the RR Donnelley workforce.

Our momentum in answering the growing demand for sustainability solutions also continues. We have told you that we have already earned Forest Stewardship Council's Chain-of-Custody Certification for our entire North America and China platforms. In addition to these important sustainable certifications, we achieved during the quarter our first Chain-of-Custody Certification from the Sustainable Forestry Institute. These certifications allow us to offer customers the option to display logos, reflecting sustainable practices on catalogs, direct mail, statements and a broad range of other documents. Our commitment to safety and sustainability are part of the reason that RR Donnelley was named among Corporate Responsibility Officer's magazine's Best Corporate Citizens for 2007.

Our reputation for performance and corporate citizenship is also attractive to companies whose resources complement our platform. This leads me to my third topic. Today's announced acquisition of offset tab retail inserts producer Pro Line Printing. This addition to our core printing business reflects our strategic approach to enhancing our platform. We continue to look for targeted opportunities to increase the number and depth of our customers' relationships to enhance our platform's flexibility, to broaden our geographic reach, to exercise our considerable front-end print media and backend logistics capabilities, to achieve immediate selling, procurement and other synergies and to add needed capacity without increasing capital expenditures.

Pro Line Printing meets these strategic criteria. In 2005, we acquired a single offset facility in Charlestown, Indiana specializing in tabloid retail inserts. We are very proud that the outstanding work done in our Charlestown facility, in conjunction with our sales and service team was just recognized by Wal-Mart, which named R.R. Donnelley as its offset tab printer of the year. This is the third consecutive time that we've been named as a Wal-Mart printer of the year.

Pro Line Printing, with facilities in Connecticut, North Carolina, Texas and Nevada, adds to our award winning capabilities and gives us a national footprint in offset inserts that mirrors our insert capabilities. We expect this acquisition to be accretive within the first 12 months after close and to quickly benefit from the RR Donnelley's brand and broader capabilities.

Pro Line Printing is also a good cultural fit with a talented workforce, rather than a troubled operation that would require a significant turnaround. We expect this to be an excellent addition to our core printing platform. We use the word platform to describe the experienced, knowledge, facilities, capacity and capabilities that we draw on to prepare, produce, deliver in process printing and communications for our customers.

The work that we have done since 2004 to expand, refurbish and integrate our platform allows RR Donnelley to achieve significant internal efficiencies. We more essentially manage utilization rates across our facilities, leverage our own buying power for equipment and raw materials and standardize procedures to facilitate functions such as safety practices, training and quality processes. Even more, it allows us to offer our customers a unique source of measurable value.

This brings me to my final set of opening comments. Thus far in 2008, we are seeing some sectors being challenged by tightening credit and more cautious consumer spending. These conditions inspire organizations to look for additional ways to achieve savings by giving more business to a single supplier that can deliver the broadest set of products and services. No organization is better positioned to do that than RR Donnelley. Our customer base in the sectors that we serve are well diversified. We have shifted more of our cost structure into a variable model by leveraging our own offshore model. We have centralized a substantial portion of our scheduling and pricing functions to enable us to move work throughout the platform to optimize utilization.

Our capital structure provide us with approximately $1.3 billion in liquidity and have a favorable maturity schedule for fixed-term debt. Unlike some heavily leveraged participants in our industry, RR Donnelley has maintained a balance sheet that gives us considerable flexibility with regard to capital deployment. And as our guidance demonstrates, we expect to generate substantial cash flow again in 2008.

In short, we believe that we are extremely well positioned to weather economic conditions, as well as to take full advantage of the opportunities that they will give rise to. For the full year, we expect that our fully diluted non-GAAP earnings per share will be in the range of $3.05 to $3.15. Again, I would like to thank our employees for their performance in 2007. We have worked hard to align their interest with our investors and we count on them to continue to position RR Donnelley as the industry leader and to deliver exceptional value to our customers.

And now, Miles will describe our performance in more detail. Miles?

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

Thank you Tom and good morning. I will now provide a detailed review of our fourth quarter and full year financial results, as well as talk about our expectations for 2008. Overall we are pleased with our fourth quarter performance as non-GAAP earnings per diluted share increased 14% to $0.80 in the fourth quarter of 2007, compared to the prior year's fourth quarter and non-GAAP earnings per diluted share of $0.70.

First is our previous guidance, a lower tax rate accounted for approximately $0.06 of this positive variance. While impressive operational performance in an uncertain global economy allowed us to deliver strong results. The integration of the three companies we acquired earlier last year, Banta, Perry Judd's and Von Hoffmann have proceeded well and these acquisitions had a positive impact on our results. Additionally, we closed our acquisition of Cardinal Brands on December 27, and welcomed their employees to RR Donnelley. Due to the timing of this acquisition, it had essentially no impact on the results of this quarter. And finally, we look forward to closing the recently announced acquisition of Pro Line Printing.

Before going into our detailed results, I want to discuss the non-cash charge for impairment of goodwill and other long-lived assets of $460.3 million in the quarter. The vast majority represents non-cash impairment charges related to our business process outsourcing reporting unit that includes our global document solutions and legacy OfficeTiger offerings. The impairment charge resulted from our annual impairment testing under Financial Accounting Standard number 142. This accounting guidance gives us... requires us to annually assess the estimated fair value of each reporting unit within our segments and compared to the related book values. In light of some of the recent business challenges and current operating results of our BPO operations, primarily in the print management offering within global document solutions, we've adjusted our future profit and consumer... customer growth expectations resulting in a goodwill impairment charge. As part of this process, we also recorded write downs of certain customer-related intangible assets in the BPO reporting unit.

Now for the fourth quarter; consolidated non-GAAP operating margin of 9.5% represents a 41-basis point increase from fourth quarter 2006 reported results. The inclusion of the acquired companies that collectively carried historically lower margins, negatively impacted our combined margins. On a like-for-like basis, adjusting for the acquisitions, we expanded operating margins by approximately 121 basis points in the quarter. Our like-for-like margins continued to benefit from strong performance in our U.S Print and Related Services segment as well as from our productivity efforts that also impacted positively on corporate costs. For the year, we delivered non-GAAP operating margins of 10% representing an 85-basis point improvement over the like-for-like margins in the prior year

Consolidated net sales in the fourth quarter were $3.1 billion, an increase of 25.2% over fourth quarter 2006 results. This increase was due to the acquisitions, new customer wins, increased volume with existing customers and favorable foreign exchange comparisons. Pro forma growth, which presents our recent acquisitions on a comparable basis, was 1.8% over the fourth quarter of the prior year. Favorable foreign exchange comparisons accounted for 202 basis points of our fourth quarter pro forma growth. Paper prices had no impact in the quarter.

Our gross margin was 25.1% in the quarter compared to 25.7% in the fourth quarter of 2006, due to an unfavorable business mix, as lower margin international growth exceeded domestic growth, more than offsetting the benefits from lower incentive compensation expense, higher sales volume and productivity efforts. On a like-for-like basis adjusting for the acquisitions of Banta, Perry Judd and Von Hoffman, gross margins decreased approximately 72 basis points.

Our SG&A as a percentage of revenue decreased to 10.5% in the fourth quarter from 11.8% in the fourth quarter of 2006, due to the benefits of our productivity initiatives, lower incentive compensation expenses and additional sales volume. On a like-for-like basis adjusting for the acquisitions, SG&A as a percentage of revenue decreased by approximately 175 basis points, compared to the prior year's fourth quarter.

Depreciation and amortization expense in the fourth quarter was $154.6 million, a $36.3 million increase over the $118.3 million reported during the comparable period a year ago, primarily reflecting the impact of the acquisitions.

The GAAP operating loss including restructuring impairment charges was a $183.4 million in the fourth quarter of 2007, compared to operating income of $56.2 million in the fourth quarter of the prior year. Excluding restructuring and impairment charges, non-GAAP operating margins increased 41 basis points to 9.5% from the fourth quarter of 2006.

Net interest expense was $59.4 million in the quarter versus $33.3 million in the comparable quarter of the prior year, primarily due to the incremental borrowings associated with our acquisitions. We recognized GAAP income tax expense of $51.0 million even though we had a loss from continuing operations, primarily because the goodwill impairment charge that drove much of the loss is not deductible. The tax rate on our non-GAAP earnings increased to 26.7% in the fourth quarter of 2007 from 19.2% in the fourth quarter of 2006, primarily due to the favorable settlement of tax audit issues in 2006.

Our non-GAAP earnings per share from continuing operations increased in the fourth quarter of 2007 by over 14% to $0.80 per diluted share compared to 2006. You may recall that our Q4 2006 non-GAAP results excluded restructuring and impairment charges and a non-cash write-down of our investment in affordable housing partnerships, as well the gain on the sale of an investment property.

Now let's turn to fourth quarter results by operating segment. Our U.S. Print and Related Services segment reported top-line growth of 19.8%, rising to $2.3 billion. Pro forma sales decreased approximately 1.9% as sales growth in logistics services, books, stock products and financial print offerings were offset by sales declines of commercial print and direct mail products.

During the quarter, we continued to manage the platform to maximize profitability. Non-GAAP operating margins increased by 7 basis points to 12.7% in the fourth quarter of 2007, as the benefit of lower incentive compensation expense was nearly offset by price pressure, the inclusion of the acquired companies in the aggregate that carried lower operating margin historically and higher non-cash purchase accounting related amortization expense. However, on a like-for-like basis including these acquisitions in both periods, operating margins increased 125 basis points from the fourth quarter of 2006 to the fourth quarter of 2007.

Our international segments reported sales grew 42.9% to $819 million, primarily due to our acquisition of Banta. Pro forma sales increased approximately 14%, of which foreign exchange accounted for 869 basis points. Pro forma sales growth was driven by strong sales in export book volume from Asia and higher sales of books, forms, labels and commercial printing in Latin America. Non-GAAP operating margins increased 57 basis points to 7.3% in the fourth quarter of 2007. On a like-for-like basis, non-GAAP operating margins were down 4 basis points.

Finally, excluding restructuring charges our unallocated corporate expenses increased $1 million to $54.6 million in the fourth quarter of 2007 as increased information technology spending offset lower incentive compensation expense. During the fourth quarter of 2007, we spent a $160.9 million on capital expenditures to bring our total year-to-date CapEx to $482.0 million or 4.2% of revenue.

For the full year of 2007, we delivered strong results with non-GAAP earnings per diluted share of $2.94, a 15.3% increase over full year 2006 non-GAAP earnings per diluted share of $2.55. Revenue grew 24.4% driven by increased volume from existing and new customers and acquisitions. On a pro forma basis, revenue grew 2.5%. Favorable foreign exchange comparisons accounted for approximately 148 basis points, while paper prices decreased revenue growth by 28 basis points.

Excluding restructuring and impairment charges, non-GAAP operating margins were 10% as we had expected. On a like-for-like basis factoring in the acquisitions, this represents an 85-basis point improvement over 2006. Our ability to drive margin expansion in a declining price environment is a testament to our focus on productivity improvements, more efficient use of our platform and seamless integration of the companies we acquired in 2007 Banta, Perry Judd's and Von Hoffmann.

And as Tom mentioned we generated nearly $1.2 billion in cash from operations. Our balance sheet and liquidity continue to be very strong. Our debt is approximately 84% fixed and an average cost of approximately 5.5% on our fixed rate debt. Our nearest long-term debt maturity is $400 million in April of 2009 and we maintain investment-grade credit ratings.

Net debt at the end of the fourth quarter was $3.9 billion. At December 31, 2007, we had $1.3 billion of available liquidity under our committed revolver. Our non-GAAP EPS guidance from continuing operations for 2008 is in the range of $3.05 to $3.15 and is inclusive of our previously announced acquisitions including Pro Line Printing and assumes no additional share repurchases.

We have provided you with a wider range of guidance relative to what we have provided to you in the past. This reflects the fact that while we feel that we are a pretty good visibility into our future operating results, we are in more uncertain economic times. Underlying our guidance are the following assumptions: we expect a somewhat softer economic in 2008. However with our broad product line and service capabilities, we expect top-line growth adjusted for acquisitions to be in the low single-digits producing revenue in the range of $12.35 to $12.45 billion.

We expect our 2008 non-GAAP operating margins be slightly better than our 2007 margin, based on sales growth and productive initiatives, offset in part by continuing price pressures. We expect $645 million in depreciation and amortization expense, inclusive of approximately $130 million in estimated purchased accounting amortizations. This is a $10 million increase in purchase accounting amortization above what we recorded in 2007. We expect net interest expense of approximately $240 million during the year and a non-GAAP effective tax rate of between 32% and 33%. Equalizing the tax rate between 2007 and 2008, produces non-GAAP EPS growth of 8% to 10%, excluding the benefit of any future share repurchases. We expect cash taxes to be 85% to 90% of booked taxes, including the benefit associated with the Economic Stimulus Act of 2008, which includes an accelerated depreciation provision. The bonus depreciation provision in the Act partly offsets the expected increase from the 2007 cash tax rate of 68%, which benefited from acquired NOLs in the exercise in the employee-stock options.

Turning to earnings seasonality, we had particularly strong operating results in the first quarter of 2007 that also included a one-time cost benefit of approximately $0.02 per diluted share associated with the retirement of our former CEO. While we will immediately in 2008 begin to recognize interest and purchased accounting amortization associated with our recent acquisitions, their synergy benefits will be more predominant in the back half of the year. Our 2008 capital expenditure outlook is approximately 3.5% of revenue, a decline of roughly $50 million from 2007, in great part due to the new capacity we acquired with our 2007 acquisitions.

Now let me make a few comments about our deployment of capital. During 2007, we had a very balanced approach, completing $2 billion of acquisitions repurchasing 7.7 million shares at a total cost of $310 million, paying $227 million in dividend and investing $482 million back into our platform. Our strong cash generation and discipline in the deployment allowed us to maintain our investment-grade credit ratings. Through a combination of solid earnings growth, disciplined capital spending and working capital management, we again expect strong cash performance in 2008.We also expect to maintain our balanced approach to capital deployment.

And with that, I will return you to Tom.

Thomas J. Quinlan III - President and Chief Executive Officer

Thank you Miles, I appreciate it. Operator, Terri, we'll open it up for questions now.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Matt Troy with Citigroup.

Matthew Troy - Citigroup

Good morning guys. I have couple of questions. I guess one at a high level, Tom this is an environment where you guys can do what you do well and that would be M&A on the print side. I was wondering if you could just talk about on the buy side, what the pipeline looks like. Then on the decision side just refresh us on the metrics you use and then on the supply side, do you have ample liquidity to do what you want to do or could do in this environment, assuming it as more opportunistic?

Thomas J. Quinlan III - President and Chief Executive Officer

I think we have done all that but if I miss it just come back at me. When you talk about the environment that we're in, I think that's one of the key things that we think that we built since 2004 and one of the things that we are excited about. When times are good everyone does well and when times aren't so good that's when you separate out and differentiate who are the people that are really adding value. That's one of the things that we are excited about here. These are going to be some challenging economic times that people haven't seen for a while. And our senior leaders know that this is where we need to add value. What we built here, what we have here is just a platform that should be able to go ahead and reward our customers with the value again that we can bring. And that's both from a pricing standpoint and from efficiencies, which again if you got one product line or two product lines, these are going to be very difficult times for you to go ahead and be able to operate in the market that we've got.

From a criteria standpoint, Troy, nothing's changed... nothing changed Matt, we're still... we look for businesses that are going to get us deeper with customers that we currently have or expose us to new customers with our capabilities. The cost structure is what I'll call is a cost structure that we can impact, that's always helpful and then finally, hopefully it has capacity. If those three criteria are there, then I think what we've demonstrated in 2007 to you is that we're able to go ahead and have a good day there, again both for the customers and for us.

From a liquidity standpoint, we talked about having a $1.3 billion out there. I would tell you that these are times when sellers are having to make decisions, whether or not they go ahead and whether or not they even have the ability to go ahead and tap the credit markets to keep their business going to invest in technology. Some people are having difficult times with that. The opportunities that are out there for us are the most that I have ever seen in the years I have been doing this and believe me it's not 25, 35, 40 years but this is a time where I don't think we've ever seen as many things come across our desk as they are coming across today.

Matthew Troy - Citigroup

On an unrelated question, you're tracking the streets statistics. Industry statistics are dangerous and that's a lot of averages might look like a pool of water you can drown somewhere on a three foot pool because there's a 10 foot pocket somewhere out there, but if I look at capacity utilization for print as an industry, its pulled back from a peak of 81, 82 sometime last year down to 77 or so. Academically, conceptually that declining utilization wouldn't augur well for pricing going forward. I know you guys operate in a brutally priced intense environment anyway. Could you just help me reconcile to looking at utilization for the industry that's coming down and maybe how Donnelley separates itself from that statistic? What kind of opportunities might be coming out of brand queue going forward or why shouldn't we be overly nervous that utilization on an industry basis has come down so much?

Thomas J. Quinlan III - President and Chief Executive Officer

Okay, I think a couple of points there. Number one, there has been so much consolidation that's taking place within the world of corporate customers, of magazine publishers, book publishers, vendors, you name it, there is many less players than what used to be there before. Again, where do we come into play and how can we differentiate ourselves? Those players are looking for someone that can go ahead and be an end-to-end solution for them and that can give them give them value from savings, for what their cost were in the previous quarter, the previous year and it also helped them operate more efficiently with their customers.

So, the industry statistics that you quote, I think are the numbers that we've come out with over the last couple of year, we will tell you that we are having pretty good days there. And I think from a planning process standpoint, the charge that John Paloian, Dan Leib and dozens of others started here four years ago was that we were going to operate this platform, as a platform and make sure that we don't operate in silos. So I don't have to worry about the book business only when I produce book products, we don't have to worry about directories, we don't have to worry about commercial assets. We look at all our assets from a centralized standpoint and make sure that they are operating at a profitable margin 24 hours a day, 7 days a week as best we can.

Now, what I think, how it occurs and I don't want to speak for other people or competitors, but I am not sure that a particular approach is shared by many in our industry. So, as people do look to go ahead and substitute or use multichannel approaches with the internet, with the web, even with wireless phones right now, you've got to have the ability to go ahead and serve them with some of those other distribution methods as well. So has print come down? Looking at some of those statistics, yes, I think there has been electronics substitution that's taken place in many different places. But at the same time, the way we run this business, there is still billions of dollars of print out there that we can still get our hands on it and its still a great marketplace to be in.

Matthew Troy - Citigroup

Last one, real quick just tactility tampering that pricing, I think we've talked about in the past and you said you wake up every year looking for pricing to be down and manage business that way. Has that changed, have we seen any down tick in pricing? Has it gotten more aggressive in the last, let's call it, two, three months?

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

No, what I would tell you it's brutalized as its always been and again our mindset going into everyday as we've got take not only pricing, but you've got salary increases that you got to go ahead and overcome, you've got benefit increases in this country and other parts of world that you have to overcome. So our productivity measures have to continue everyday to look, to see how we can overcome that. And I think... again with the numbers, whatever I can tell you here, the numbers should speak for themselves and what we have been able to do and continue to do and I think our value that we add is that if someone wants to take today's acquisition announcement for example, someone wants to take a review of retail insert and put it on offset, we have got the capability to do that. That's not going to leave our platform. That's not going to go to somebody else, now. We have got that, we can help from there, we can help them re-versioning, we can help them hit midweek time horizons as George also knows. And that's going to be another plus for us to where branded pricing is passing. At the end of the day, we have got to deliver savings for our customers. But we've got that platform to go ahead and do that.

Matthew Troy - Citigroup

Thanks a lot. Thanks Tom.

Thomas J. Quinlan III - President and Chief Executive Officer

Thanks Matt.

Operator

Your next question comes from Charles Strauzer with CJS Securities.

Charles Strauzer - CJS Securities

Good morning.

Thomas J. Quinlan III - President and Chief Executive Officer

Good morning Charles.

Charles Strauzer - CJS Securities

Yes. Good morning how are you. I'm just thinking about Matt brought out there, if you look at kind of the competitive environment and with the problems that your largest competitor has had going into bankruptcy, are you seeing any significant disruption in the sales cycles when you're competing head-to-head with them your currently and kind of talk about what your customers have said to you when they have looked at some proposals by your competitor.

Thomas J. Quinlan III - President and Chief Executive Officer

I don't want to probably get into too much about other people. I think I was taught that at a young age, but what I would tell you about us is that we're a safe pair of hands for people right now. We've always felt that way, could I say we are the printer of choice. I'd stand up proud and say that. I think again when... these are not commodity products that people are talking about that their... that they may do in our industry and in a long run side of the business. So these are products that are the lifeline for those companies. So as companies are making decisions, they want to make sure that their partner, their vendor is somebody that they don't have to worry about. The last thing we want to do is be a nuisance or problem to one of our customers and I think again, the way we've deployed capital here, we've made sure that we haven't grown beyond our means. We've been prudent with the way we've deployed capital and we'll look to go ahead and continue to do it that way. And as a result of that, I think our business and our platform is going to benefit from that.

Charles Strauzer - CJS Securities

Right and then, just if I can get a clarification. Basically, you're saying that you guidance includes what you think is a softening economy, a tough economic environment overall, tough pricing environment overall. But yet you're still factoring in growth for both top line and bottom line, is that correct?

Thomas J. Quinlan III - President and Chief Executive Officer

That's correct Charles. I mean look, we're less than 60 days into a time period where I think most of us on this phone haven't seen something like this in a long time and if you have, it's been many, many years ago and technology has changing and all this other crazy stuff that's going on. We feel good as we sit here today with the range that we gave you. I think if you go back to August of 2007, where we sat on the phone with you and we saw that we saw a credit crunch that was about to happen and we gave some guidance there. We know how important it is not to mislead people when we think as we sit here today with our platform, this is where we should be able to come out.

I mean the biggest thing, the biggest question I got... get asked these last of couple of weeks, when I go around the facilities is what keeps you up at night and what keeps me and our other senior managers up at night is we know that this is the time that we can go ahead and really strive and really make great progress with our customers, and we can't let that opportunity go by. So, I think we are into challenging times, we are not going to use it as an excuse and we are fortunate to have the platform that we have.

Charles Strauzer - CJS Securities

And then Tom, when you look at the acquisitions you've made recently and the integration efforts underway there; are those complete now or are there still more synergies to be extracted as the year progresses?

Thomas J. Quinlan III - President and Chief Executive Officer

Look everyday we got to find synergies, but what I would tell you that as I think Miles gave you some insight to some of the things you talked about some of our guidance for 08. Our corporate expenses there I mean we are looking to put more IT initiatives in because we think we can get more productivity if we can do certain things in the IT area. And I think as we think about everyday, is it done when you ask question are you done? We are never done. I mean, do we feel great and again do the numbers illustrate it? Yes. But everyday we got to continue to look to see how we can make ourselves more productive.

Charles Strauzer - CJS Securities

Got it. And one technical question for Miles. The guidance you gave for interest expense of $240 million that's seems to be a little bit of a higher rate than kind of factoring in the math of 5.5% or 85% of your debt being fixed. What rate assumption are you using on the debt and what total debt assumption are you using as well, because it seems a little bit high. And are you factoring in cash interest, interest on in any cash earned in that number?

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

We are, it's a mix. We don't have it... it's primarily the same rates we've been assuming in our facilities now, without any major change in the market. We anticipate being able to continue to access our committed facility as well as other fund if necessary. So there is still some cash interest income that's going into that.

Charles Strauzer - CJS Securities

Like I'm saying it's 240, that would assume given all interest rate probably in the mid sixes where you're kind of blended interest rate and just with a declining rate environment that would seem a little high to follow the cycle.

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

You may be missing that, we were factoring the Pro Line acquisition that we just had additional interest on the acquisition cost of that.

Charles Strauzer - CJS Securities

I'm factoring that as well, just or so saying that, help is almost at coming at pretty high rate given your credit rating I would think that that's probably not the correct assumption.

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

Yes you know what Charles one other things or two I think that we talked about earlier which I don't want anybody to get lost, I think the guidance that we gave last year for this year regarding capital expenditures, we said we've been in a range of 3.5% to 4% and we're happy to report today that we're going to be at the lower end of that range, which obviously has significant cash generation for us by being at that range.

Charles Strauzer - CJS Securities

Thank you very much.

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

Thank you.

Operator

Your next question comes from Piyush Sharma with Longbow Research.

Thomas J. Quinlan III - President and Chief Executive Officer

Good morning.

Piyush Sharma - Longbow Research

Firstly could you give us some color on potential for incremental margin improvement at your acquired platforms?

Thomas J. Quinlan III - President and Chief Executive Officer

I am sorry, you broke up there I apologize.

Piyush Sharma - Longbow Research

Okay, if you could give us some color on potential for margin improvement to your acquired platform such as Banta, Von Hoffmann and Perry Judd?

Thomas J. Quinlan III - President and Chief Executive Officer

I am sorry, I think I got you now. I think what we said today on the call was that we go from 10% to slightly above 10%.

Piyush Sharma - Longbow Research

Okay and any particular initiatives or any particular pockets that you believe have more room to improve than others?

Thomas J. Quinlan III - President and Chief Executive Officer

Yes, I mean its pennies, nickels, dimes. Somebody very smart told me that one day and we will look from shrink wrap to safety goggles to what we do with the wood pellets to make sure that when they break we use them and then we'll recycle them. So it's everything that's within our facilities with outsider facilities from support functions all the way down.

Piyush Sharma - Longbow Research

Okay, couple of housekeeping questions there. What are the impact if you could quantify a lower incentive compensation expense and increased IT spending on margin in fourth quarter and secondly, was IT spending primarily related to acquired platforms or it was really company wide?

Thomas J. Quinlan III - President and Chief Executive Officer

I will take IT spending first. IT spending is always company wide and we are always looking to go ahead again from IT, if you cannot buy at home we can go ahead and get synergies, we can improve our productivity and efficiencies. And then I will let Miles talk about basis points that we got from... in the fourth quarter.

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

The incentive comp, it was about 100-basis point benefit in the fourth quarter.

Piyush Sharma - Longbow Research

And IT spending was how much of a drag?

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

We haven't disclosed that, nor would I want to disclose down to that detail.

Thomas J. Quinlan III - President and Chief Executive Officer

And the incentive comp on an annual basis was essentially flat in dollar terms that was just how it was recognized through the quarters.

Piyush Sharma - Longbow Research

Okay. And then finally in the guidance that you are giving of $12.35 billion to $12.45 billion, what contribution if you could tell me is from Pro Line and what are you're expectations in your international business there?

Thomas J. Quinlan III - President and Chief Executive Officer

Yes, we don't want to break it like that. But it does include... the guidance there doesn't include Pro Line. So we don't want to breakout this specific amount and the same goes with our international business.

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

What I would tell you look the business that John Brown and Lesley Dover have built over the years is a great business, again great employees and we are looking forward to adding them to the Donnelley's family.

Piyush Sharma - Longbow Research

Could you give us some color on your expectations in your international business?

Thomas J. Quinlan III - President and Chief Executive Officer

No, not at this time. I mean, we are still we are going to be consistent with the way we've gone through these calls over the last year or so and continue that way.

Piyush Sharma - Longbow Research

Okay. And finally your FX assumption is exactly the exchange rate as it stands right now.

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

For the most part, we are not factoring any big moments one way or the other.

Thomas J. Quinlan III - President and Chief Executive Officer

Nor will we use that as an excuse if it goes against us.

Piyush Sharma - Longbow Research

Understood. Thanks a lot guys.

Thomas J. Quinlan III - President and Chief Executive Officer

Thank you.

Operator

You're next question comes from comes from Giles van Praag [ph] with Atlantic Investment.

Thomas J. Quinlan III - President and Chief Executive Officer

Good morning.

Unidentified Analyst

Good morning, excuse me two questions if I might; one just a sort of follow-up on Piyush's line of questioning. On the corporate expense line going forward, you mentioned that you're going to continue to invest in IT et cetera but, for the guidance you've given us can you tell us what the baked in for that corporate expense line?

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

I think we said the range of $200 million and $220 million.

Unidentified Analyst

Okay excuse me. Bigger picture it's a long-term type of question looking at margin structure, the two pieces of the business can you talk at all about the opportunities for the international side to continue the close the gap a little bit with the U.S side, just sort of conceptually where that might be able to go over the next couple of years?

Thomas J. Quinlan III - President and Chief Executive Officer

Sure, I mean John [ph] as you know I mean international is as tougher battlefield as any that are out there, in especially in Western Europe. We've got some key sale wins that we've got direct read segment, the high-end magazine segment and the technical documentation part of our businesses done... is done well and we're seeing some good things take place there. And we're still the leading provider of printing-related services in Central and Eastern Europe, Germany and U.K. So, we think that is going to get going and continue to get going. But again it's a competitive landscape that we fight there along with many other people.

From a what I call the global document solutions standpoint that we talked about this morning with the charge, one thing I don't want anybody leaving this call thinking is that... we're not having success there, we're not putting resources in time and effort in that business. We're having some good real success there in transactional statement printing, the BPO contracts and some new outsourcing contracts that is going on so, which standing contracts and our winning you there. We've got to get better at it over there and I sit here before you and tell you that the announcements as far as charges, I'd be very surprised if next year we sat here and we're talking about a charge related to that business.

Asia, Jim Mark's leadership over there, again we continue to serve the domestic Chinese market as well as to be a place for exports both here and to other parts of the world. The six facilities over there, 6000 people just again, that model for us and we again... I'm fortunate to thank probably management teams from 15, 20 years ago that had the foresight to get over there and get involve there. And that is still a great market for us and we are excited about what the possibilities are there.

Unidentified Analyst

Great and then just lastly one more sort of housekeeping one; on the McGraw-Hill contract announcement from yesterday when does that kick in and how much of that might be incremental to what you currently do for them?

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

Yes and that's something I am not going to go through detail plan but in essence day one always kicks in and in our numbers that we gave you today the McGraw-Hill contract is built-in there for 2008.

Unidentified Analyst

Okay, thank you.

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

Thanks Giles.

Operator

Your next question comes from the line of Karl Choi with Merrill Lynch.

Thomas J. Quinlan III - President and Chief Executive Officer

Good morning Karl.

Karl Choi - Merrill Lynch & Co.

Hey good morning, couple of questions here. One I wonder if you can be little more specific about the BPO segment performance either in the quarter or for the year is it more as a profits problem or is it both top-line and profit and what should we think about top-line at least for 2008 for this business and I guess related to that is there any intentions to think about maybe divesting the BPO business?

Thomas J. Quinlan III - President and Chief Executive Officer

Thanks Karl. What I would say Karl and look I'm getting out of my realm of definitely expertise then I start talking about FAS-Bs but, FASB 142, I think is a Miles and team have gone through. There is assumption made when you make an acquisition and you got to see how you're going ahead and performing versus those assumptions. And if you go back a couple of years, we had some pretty interesting assumptions or we thought, prior management might have also thought that was going to be a business that was really going to take off and flourish and with all the businesses that we are in, scale does become a prominent player.

So I would not look at the charge that were taking today and saying okay the business is not... is falling off a cliff but what I would say and opposed to that is we have seen some good revenue opportunities there that we need to translate in the bottom line and I think with Tommy Yuehaass' team and their expertise from a financial standpoint, and a legal standpoint, we're winning business and we're making sure that more it falls to the bottom line and utilizing that particular product line like we do with the print-related companies.

As it relates to the divestitures, I mean I think what I would answer it this way would be to tell you I think we've got the expertise in house now. I think we've learnt everything that we can possibly learn in this business on the BPO side and we've got to make it better.

Karl Choi - Merrill Lynch & Co.

Second question I have is Tom you mentioned that in 2008 so far, you've seen some segments are more challenged. Can you be a bit more specific about what categories you're seeing the weaknesses and also geographically, is it more U.S. versus international.

Thomas J. Quinlan III - President and Chief Executive Officer

Yes, I think a couple of things there, I mean, one obviously capital markets are not having activity as you and the others on the phone know that they had in 2007 start out. So that's a given right there. Although in Asia and Europe up to probably this time right now 2008 has been okay. So I think again the platform... the breadth of the platform being global has helped to offset some of the challenges that we see there. People are coming to us and asking us for their help. we're going to them and telling them what we can provide help for them to look at different ways to go about maybe size changes, maybe it's more versioning to go out but people are seeing a need to continue to reach out to their customers. And again, I think the size of our platform, where there are weaknesses or where somethings may be down other parts of it are up. Directories for example obviously the housing slump has impacted those particular customers of ours, but they've impacted in different ways and again I think our ability to help them be the book of choice in the house that they are going to help them to go ahead with multilingual copies that they want to do.

The fact that we work in for Mexico, U.S, Canada, that's a help for them. The companion guides that are coming out, those are still big. So, again it's a balancing act that takes place across the board. I mean trans promo printing in our statement business. The fact that we have color, the fact that we can go ahead with the speed of our proprietary machines and what we have going on is helping our customers out there. Are they cultivating their list? Yes. Are they are making sure that they're mailing... they're mailing to people that they may have different criteria for. Yes. But again as far as we're sitting here today we think and again the guidance that we are giving you that we think will incorporate all that in.

Karl Choi - Merrill Lynch & Co.

Lastly, just wondering, in terms paper, do you expect paper to provide a little bit of a lift to your top line in 2008, given the higher paper prices. Or I guess it also depends on volume of our customer register for you guys.

Thomas J. Quinlan III - President and Chief Executive Officer

Yes I mean that that's a correct answer. But there a couple of different criteria there and it will depend on both of those workout.

Karl Choi - Merrill Lynch & Co.

Great thank you.

Thomas J. Quinlan III - President and Chief Executive Officer

Thanks Karl. Operator, we've got time for two more questions.

Operator

Your next question comes from Edward Atorino with Benchmark Company.

Thomas J. Quinlan III - President and Chief Executive Officer

Good morning Ed.

Edward Atorino - The Benchmark Company

You mentioned -- hi, how are you? You've talked about some of the product categories. Could you sort of give us some idea where the key trends say in the magazine sector for example and financial pruning going into '08?

Thomas J. Quinlan III - President and Chief Executive Officer

Yes let me start with magazine. I mean magazine still play an important role in influencing consumer behavior and if anybody doesn't think they do they are mistaken. The thing that has to take place there though is the still is a multi-channel approach to it. So, the publishers that have figured this out are the ones that are doing well where they got a great portable product and they also have a real vibrant website so that people can go ahead and use both and we are seeing those and there is new launches that are taken place. Obviously, there's consolidation that continues to take place in the magazine and the catalogs and that we don't see changing at all.

Financial print is again as I talked about, the good part there with our people is the relationships that they have, I think we have talked about last year I think 5% of our top-line comes from financial print and about half of that comes from capital market activities and the people that are out there pounding the street for us, knocking on doors are doing a heck of a job trying to talk to our customers both in the financial world, legal world and the corporate world about the rest of the platform that we have to offer and we really starting to see some headways here.

Edward Atorino - The Benchmark Company

Given the economy of catalogs holding up in the first quarter and magazine ad pages?

Thomas J. Quinlan III - President and Chief Executive Officer

I don't want to get into too much detail. Yes, but I would tell you its catalogs again the co-branding and brand extension that's taken place is huge for catalogs. We have got to mitigate all these other cost that take place whether its postal increase, paper prices we got to help them mitigate that and then I think when you think about us and when you think about how we can go ahead and do that logistics is a key driver for us to go ahead and get that done and we have expanded our co-palletization and co-mail services in our operations in Illinois, in Pennsylvania. We are adding co-mail services for Poly bag and large format publications and again, I think are adding additional list process and capabilities to comply with move update is that's going to be in November is huge for us and I don't think again, I'd challenge anybody else who's out there who has the platform that's going to be able to bring those services to our customers.

Edward Atorino - The Benchmark Company

Thanks, so much.

Thomas J. Quinlan III - President and Chief Executive Officer

Thanks Ed.

Operator

And your last question comes from Jake Kemeny with Morgan Stanley.

Jake Kemeny - Morgan Stanley

Hi. Good morning if you could give us a little bit of guidance around cash from operation for 2008?

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

We are not give any specific guidance on it but as I mentioned we still expected to be strong similar to this we had in 2007, we don't significantly expect it we had about 1.7 billion of EBITDA in 2007 though probably 15% to 20% increase after that EBITDA minus CapEx in 2008. So we'll see the benefit of our lower CapEx spending and the acquisition additional capacity that we acquired in 2007.

Jake Kemeny - Morgan Stanley

Okay great, thank you.

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

Thank you.

Thomas J. Quinlan III - President and Chief Executive Officer

Operator, thank you. I appreciate everyone taking the time to listen in and hope that everybody enjoy the rest of the week. Thank you.

Operator

This concludes today's call you may now disconnect.

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Source: R.R. Donnelley & Sons Co. Q4 2007 Earnings Call Transcript
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