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

Q3 2012 Earnings Call

November 01, 2012 10:00 am ET

Executives

David A. 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

Charles Strauzer - CJS Securities, Inc.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Kannan Venkateshwar - Barclays Capital, Research Division

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

Joseph S. Rodbard - Providence Equity Partners LLC

Operator

Welcome to the RR Donnelley Third Quarter 2012 Results Conference Call. My name is Richard, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. Dave Gardella. Mr. Gardella, you may begin.

David A. Gardella

Thank you, Richard. Good morning, everyone, and thank you for joining us for RR Donnelley's Third Quarter 2012 Results Conference Call.

Earlier this morning, we released our earnings report, a copy of which can be found in the Investors section of our website at rrdonnelley.com.

During 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 Investor section, a description, as well as reconciliations of non-GAAP measures to which we will refer on the call.

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

Thomas J. Quinlan

Thank you, Dave, and good morning, everyone. I'd like to begin by adding my voice to those all over the world that are expressing thoughts and prayers for the people who are impacted by the East Coast storm, as well as gratitude to the first responders and others who continue to help people deal with the storm's aftermath. An event like this one makes the phrase, Disaster Recovery Capabilities, very real. It has certainly made it real to us at RR Donnelley and to the customers who depend on us for continuity of service.

Our ability to plan ahead for contingencies, to transfer work electronically to other RR Donnelley facilities that were not affected and to have those operations pick up and deliver needed projects, has made a significant difference for our customers. This ability is something that customers evaluate pretty carefully as they are considering where to place their business, and it is a resource that we fully exercised in dealing with this huge storm.

I'm extremely proud of the way that our employees have risen to the occasion. So many have kept work commitments, even as they have been dealing with power outages and even much worse at their homes and in their communities. It is precisely because of our peoples' ability to rise to the occasion that we were also disappointed by the deeply regrettable premature filing of a customer's 8-K to the SEC that occurred on October 18. Everyone at RR Donnelley wishes it could have been undone. In a business in which we strive for perfection, an exceptionally rare and exceptionally unfortunate human error created turmoil for a valued client. As you know, in this fast-paced business environment, there are some steps that, once taken, cannot be taken back. This was one of those.

While we cannot retrieve the transmission, we could and did undertake an immediate and exhaustive set of reviews to determine if our technology, systems and protocol performed as designed. They did perform and they have historically performed and will continue to perform as we execute more than 100,000 similar filings this year. We have been supporting companies' compliance and reporting needs for decades and have invested significantly in our people, processes and technology throughout those years in support of our valued clients. Our quality and governance processes include an ongoing focus on continuous improvement, and we have already begun to implement additional process and system enhancements that will help to prevent an extremely rare incident like this from happening again.

For all of our employees, this incident was a vivid reminder of how closely integrated RR Donnelley is with our customers, especially as we continue to provide a range of services that extend far beyond printing. Every day, we are working behind the scenes to help our customers connect content -- connect with the right audiences at the right time to deliver the right results. Our creation, production, management and distribution of content frequently occur in real time speed. This work that we do for our customers reflect deep integration with them and includes custom programming, e-communications, desktop and mobile platforms, digital archiving and distribution, sophisticated logistics, supply chain management, packaging services and much more.

With regard to the third quarter, we confronted significant demand headwinds as customers in a range of segments and geographies began exercising more caution about expenditures. Nonetheless, we posted GAAP income from operations of $186.7 million, up 19.1% as compared with the same quarter a year ago. During the quarter, GAAP operating margins of 7.4% were up 160 basis points from the comparable quarter in 2011. We are always operating at 100% in terms of our sales efforts, and we also always act quickly to match costs to revenues. In doing so, we work from the shop forward to the management offices to ensure that our employees' interests are aligned with our shareholder interest.

As I've mentioned, and consistent with what has been experienced by other companies in a number of industries, we saw a downtick in demand in the quarter. Though topline was challenging, we saw positive results in our services offering, which is up by 6% during the quarter. This was driven in part by our logistics revenue, which increased by 8% during the quarter as compared with the same quarter of last year.

Let me add a little color to what we're doing in logistics, which has experienced meaningful revenue growth over the last few years, quietly surpassing many of the print-related elements that many people most associate with RR Donnelley. Our logistics capabilities include co-mailing, co-binding and co-palletization services, as well as third-party logistics or 3PL services for less than truck load, full truckload, intermodal, domestic and international air, courier, ocean and expedited air. As I've mentioned before, we have grown this business without capital investments in a fleet of trucks or other vehicles. Another attractive aspect of the strategy is that we are able to take advantage of the opportunity to leverage our existing customer base and our transportation scale to aggressively pursue ongoing growth in logistics.

For example, during the quarter, we expanded our logistics offering with the acquisition of Express Postal Operations (sic) [Options] International, better known as XPO, a privately held company based in Torrance, California. We're pleased to welcome the talented XPO professionals who will complement our logistics offering.

This operation, which we have already moved swiftly to integrate, provides international outbound mailing services to pharmaceutical, eCommerce, financial services, information technology, catalog, direct mail and other businesses. It manages international outbound mail delivery to more than 150 countries. Again, please note the diversity of the vertical segments that this offering serves.

During the quarter, we also completed the acquisition of EDGAR Online, which further broadened the already expansive suite of financial services that we provide to thousands of clients. In addition to disclosure management services, EDGAR Online provides a portfolio of financial data and enterprise risk analytics software and solutions. We are pleased to welcome EDGAR Online's talented professionals, who have further strengthened our innovative Information Technology platform. This acquisition is another example that demonstrates how we are not naive to the trend towards multichannel communications, and we will continue to serve our customers around the world in a broad variety of segments with a balanced service offering.

Before I turn it over to Dan, let me reiterate the 5 elements of our strategy, which we believe represent the correct approach to dealing with the external environment in furthering our internal transformation.

First, 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. Despite electronic substitution, there's a lot of print to be won. We are aggressively pursuing every piece of it that makes business sense for our platform.

One advantage that we have is our ability to offer customers single-source solutions across product categories and borders. For example during the quarter, Rockwell Automation named RR Donnelley as its Indirect Supplier of the Year. We serve this customer with an array of printed and digital products in the United States, Canada, Asia, Mexico and Europe.

We also renewed and expanded our relationship with AARP to continue to producing 100% of the 2 largest circulation print publications in the world. Note that this multiyear agreement also includes direct response, pre media and logistics services.

The second element of our strategy is leveraging our unmatched operating expertise, procurement scale and customer relationships. Again, this is a standing order for all of our operating functions, from sales to supply chain to information technology, which continues to play an increasingly important role in helping to win business and to generate internal efficiencies.

The third element of our strategy is building on our relationships with customers internationally to sell more services that can diversify and increase our revenue base. This strategic pillar comes to life in a variety of ways. For example, during the quarter, I was pleased that the quality and reputation of our business process outsourcing services were recognized in a number of categories by the International Association of Outsourcing Professionals in its 2012 Global Outsourcing 100 Ranking.

Again, it is not uncommon for people who think of RR Donnelley as only a printer to be surprised to learn that we were named as one of the very best in delivering legal support services.

The fourth element of our strategy is to 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.

Let me share just a quick example of how we are using RR Donnelley technology to extend the range of value that we can provide to our customers. Before the year is out, we will be helping a customer launch a communications effort that will use print and email to drive millions of respondents to secure PURLs or personalized websites.

Once there, the respondents will authenticate their information and then be introduced to a further explanation of the options that they can choose through variable video. This video actually is responsive to the respondent's individual profiles. The options presented are different depending upon who you are. RR Donnelley professionals are providing creative services, reporting and analytics, generating the PURLs, delivering programming services and coordinating a full range of communication services, in both print and electronic form. Variable video and authenticated PURLs are innovative new services that customers may not have expected to see from RR Donnelley even just a couple of years ago. They are, however, just some of the technologies that continue to diversify our offering.

The final leg of our strategy is to work to drive free cash flow and margin through continuing aggressive costs compression. As we have made clear and again demonstrated during the third quarter, this is a pillar that attracts everyone's attention at RR Donnelley. And now, Dan will take you through our results in more detail. Dan?

Daniel N. Leib

Thanks, Tom. The combination of the sluggish economic environment and continued industry secular dynamics continued to negatively impact our top line. Our third quarter operating results are reflective of our ongoing commitment to aggressively manage our cost structure in light of these impacts. Third quarter 2012 GAAP operating margin of 7.4% grew 160 basis points over the third quarter last year, while non-GAAP operating margin improved 90 basis points in the same period. This translates to a year-over-year increase in GAAP and non-GAAP income from operations of $29.9 million and $10.2 million, respectively. GAAP earnings per diluted share were $0.39 in the quarter, while non-GAAP earnings per diluted share were $0.51. Our non-GAAP net earnings per share were flat to the third quarter of last year as we managed to overcome a 6.5% decline in revenue and a 900 basis point increase in our effective tax rate through improved operating margins.

Our revenue of $2.5 billion in the third quarter of 2012, when adjusted for the impact of acquisitions, unfavorable changes in foreign exchange rates, and the impact of lower sales of paper, was down 5.2% organically from the third quarter of 2011. This was primarily due to volume declines and price pressure across several of our U.S. and international offerings, partially offset by volume growth in logistics, Asia, Global Turnkey and Business Process Outsourcing, many of the same offerings in which we also experienced year-over-year volume growth in the second quarter this year.

Third quarter gross margin of 22.8%, declining 60 basis points from the third quarter of last year, representing the fourth consecutive quarter in which we have seen improvement in the year-over-year gross margin trend. Unfavorable pricing on byproducts, lower volume and continued price erosion more than offset lower variable compensation expense, cost reduction efforts and lower pension and post retirement expense. SG&A expense in the quarter as a percentage of revenue of 10.1% was 100 basis points better than the third quarter of 2011, driving the improvement or targeted cost reductions in our selling and administrative functions and lower pension, post retirement and variable compensation expense.

For 4 consecutive quarters now, on a year-over-year basis, we have reduced our SG&A expense both as a percentage of revenue and in absolute dollars.

Third quarter non-GAAP operating income of $201.9 million improved $10.2 million from the third quarter of 2011 and reflects a 90 basis point increase in the margin rate versus the third quarter of last year. Driving the margin improvement were lower variable compensation, lower pension expense, lower depreciation and amortization, savings from productivity initiatives and a lower LIFO inventory provision, which more than offset the impact of volume declines and unfavorable product mix, price erosion, unfavorable pricing on byproducts and the reinstated 401(k) match. Changes in foreign exchange rates did not have a material impact on the quarter-over-quarter margin comparison.

Our non-GAAP effective tax rate in the quarter was 33.1% compared to the low rate of 24.1% that we realized in the third quarter of 2011, which was related to certain state tax matters.

From a segment perspective, revenue in our U.S. Print and Related Services segment of $1.9 billion declined by 6.4% from the third quarter of last year or 6.9% on a pro forma basis after adjusting for the impact of acquisitions. Reduced pass-through paper sales continue to impact our tonnage print offerings of magazine, catalog and retail and book and directories, comprising 93 basis points of the year-over-year decline. Ongoing price erosion across the U.S. segment negatively impacted the quarter as well.

Consistent with the first half of the year, we continued to see revenue growth in 2 of our service-based offerings, logistics and pre media. However, the challenging industry dynamics and the global economic environment contributed to declines across our traditional print-based offerings. We continued to experience volume declines in our book and directory and financial print offerings, and although the year-over-year performance in the third quarter improved relative to the declines we experienced in the first and second quarters this year, the trend did not improve to the extent we had previously expected. In addition, 2 of our more economically-sensitive offerings, commercial print and variable print, experienced significantly more decline in the third quarter than experienced earlier this year.

Non-GAAP operating margin for the segment of 10.1% improved 10 basis points from the third quarter of last year as productivity improvements, a reduction in variable compensation expense and lower depreciation and amortization expense more than offset volume declines and unfavorable product mix, unfavorable pricing on byproducts and continued price erosion.

Third quarter 2012 revenue in our International segment of $655.4 million declined $48.5 million or 6.9% from the third quarter of 2011. Approximately 2/3 of the decline or $31.9 million was the result of unfavorable changes in foreign exchange rates, with the remainder of the decline primarily due to the production of a significant customer order that was moved into the fourth quarter this year, whereas in 2011, it was recognized in the third quarter.

Ongoing price pressure also impacted the quarter and, consistent with the second quarter, increased pass-through paper sales, primarily in Asia, contributed $6.1 million or 86 basis points to the top line.

Building on the momentum we gained in the second quarter, we continued in the third quarter to see volume growth in Asia, Global Turnkey and Business Process Outsourcing. Non-GAAP operating margin for the segment declined 100 basis points to 4.9% from 5.9% in the third quarter of 2011, primarily due to an unfavorable product mix, price pressure and wage and other inflationary increases, notably in Latin America and Asia, partially offset by a reduction in variable compensation expense, lower depreciation and amortization expense, a 39 basis point impact of favorable changes in foreign exchange rates and productivity improvements.

Our third quarter 2012 non-GAAP unallocated corporate expenses were $18.1 million, a decline of $28.9 million from the third quarter of last year. The improvement was driven by lower pension and post retirement benefits expense, a lower LIFO inventory provision, a reduced level of variable compensation expense and targeted cost reductions, partially offset by the 2012 reinstatement of the 401(k) match and higher employee benefits related expense.

Operating cash flow in the quarter was $159.5 million compared to $303.7 million in the third quarter of last year. Over half of the $144.2 million decline was related to higher pension contributions, which increased by $76.3 million from the third quarter of 2011. On a trailing 3-month basis, controllable working capital, which we define as accounts receivable plus inventory less accounts payable, as a percentage of net sales was 14.7% at September 30, 2012, an improvement of 10 basis points over September 30 of last year.

Given third quarter results and the outlook for the fourth quarter, we now expect full year free cash flow, or operating cash flow less capital expenditures, of approximately $450 million, which implies free cash flow of approximately $440 million to be generated in the fourth quarter of 2012 compared to $417 million in the fourth quarter last year. Included in our full year free cash flow are contributions to our pension, post retirement and 401(k) plans of approximately $184 million, which are approximately $126 million higher than the contributions we made to these plans in 2011. Typical seasonality and working capital, along with targeted reductions in this area, will drive a majority of the cash inflow projected for the fourth quarter.

Total debt as of September 30, 2012, was $3.8 billion, an increase of $25 million from June 30, 2012, and $152.8 million lower than at September 30, 2011. In the quarter, we closed 2 acquisitions, EDGAR Online and XPO International, for approximately $90 million. As of September 30, 2012, our term debt is 73% fixed, at an average interest rate of approximately 7.5%, and our next scheduled term debt maturity of $258 million is not due until April 2014. At quarter end, we had borrowings of $344 million under our prior credit agreement.

Subsequent to the end of the quarter, on October 15th, we finalized the terms of our 5-year $1.15 billion secured revolving credit agreement. Our net available liquidity at the end of the quarter under the new credit agreement was $1.2 billion, which is supported by cash holdings of $393 million and $767 million of additional availability under the agreement.

Similar to our previous credit agreement, there are 2 compliance covenants: interest coverage and leverage. The interest coverage ratio covenant is consistent with the prior facility at 3x. At the end of the third quarter, we were at 5.1x. The leverage ratio covenant in the new agreement is at 3.75x through the end of 2014, dropping to 3.5x in 2015 for the remainder of the agreement. At the end of the third quarter, we were at 3x. As I just noted, the seasonality of our cash flow is heavily weighted towards the fourth quarter and, given the expected fourth quarter cash flow, we expect to reduce debt and end the year within our targeted growth leverage range of 2.5x to 3x.

I should also note that we have benefited from asset sales during this year, resulting in approximately $42 million of net proceeds. While these amounts are not included in our free cash flow calculation, they have been a source of cash and help in managing our leverage.

With one quarter to go, I want to provide updated guidance for the full year of 2012. As we noted in this morning's release, our guidance assumes that Hurricane Sandy will not have a significant impact on demand for our products and services or on the company's operating results. We expect revenue to be in the range of $10.1 billion to $10.2 billion, including the unfavorable impact of changes in foreign exchange rates and pass-through paper sales of approximately $170 million. This implies full year revenue of down approximately 3% to 4% on an organic basis.

Consistent with prior guidance, we expect our non-GAAP operating margin to be in the range of 7.2% to 7.3%. Included in this range are corporate expenses of approximately $150 million to $170 million, an improvement from previous guidance of $20 million to $30 million.

Depreciation and amortization expense is expected to be approximately $485 million. Interest expense continues to be -- estimated to be in the range of $250 million to $255 million. Our full year non-GAAP tax rate is expected to be in the range of 30% to 33%. We project the full year, fully-diluted, weighted average share count to be approximately 182 million shares. As such, we expect full year non-GAAP earnings per diluted share to be at the lower end of our previous range of $1.84 to $1.92 per share. We expect capital expenditures to remain in the range of $200 million to $225 million. Lastly, as I mentioned earlier, we expect operating cash flow less CapEx of approximately $450 million, which is inclusive of approximately $184 million of cash contributions for our pension 401(k) and post retirement plans. Looking ahead to 2013, we expect contributions to our pension and post retirement plans to decrease by approximately $110 million.

As I mentioned earlier, we expect our gross leverage ratio to decline in the fourth quarter and in the year within our targeted range of 2.5x to 3x, and intend to maintain our focus on debt reduction to remain within this range. And with that, I will turn it back to Tom.

Thomas J. Quinlan

Thank you, Dan. Richard, we'll now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Charlie Strauzer from CJS.

Charles Strauzer - CJS Securities, Inc.

Tom, if we could talk a little bit about kind of the booking trends that you're seeing, kind of as you look forward as you're having conversations into next year, can you give us a sense if we're seeing -- if we've seen the inflection point yet? And are we seeing -- what areas are kind of seeing kind of the growth coming back a little bit?

Thomas J. Quinlan

Obviously, I think, as everyone saw, other companies that were coming out reporting their earnings for the quarter, there were a number of companies that missed on the top line but got there on the bottom line. And we are obviously one of those companies as well. As you look to go back and think about the third quarter, you had Asia slowing down, Europe started to show signs of being in a recession and companies, quite frankly, stopped spending. The discretionary spending actions were a big part, in our minds, as far as how companies got to achieve the bottom line targets that they got to achieve. In addition, advertisers started to become cautious and postponed or canceled programs. But with all that going on and all that, we did not stop selling. In the quarter, we sold, renewed or had new business with a contract value of $1.3 billion. So as we sit here today, the proposition that RR Donnelley has to offer our customers is of value and those types of numbers validate that. For the short term, when people -- when there's a systematic shutoff by our customers of spending, there's not much we can do but in the long-term, there definitely is, and we've got to continue to bring forth the fact that we can reduce their costs and improve their return on investment. When we sit back and look, if you just -- and again, the last couple of days with all that cast [ph] that's taken place, when I think about what sets us apart from all other companies, and if you can just close your eyes and just if you heard the words that you had financial strength, you had the broadest range of products and services, an industry-leading scale, ability to manage customers, total supply chain, ongoing reinvestment into the platform and innovation and technology, to me, that's somebody that you want to be with and that's what we have. As you sit back and look at things that are taking place, that's what differentiates us from everyone else. Whether the economy is going good or bad, as you know, we're going to manage it the same way every day no matter what's taking place. I think from a growth standpoint, when you look at some of the things that we've invested in from a technology standpoint that have opportunities down the road, I mean Solicore is a good investment that we made right there. For those who don't know, we're trying to use printing presses to create products that aren't just for traditional print products. We're researching ways to print the kind of batteries that power products such as smart cards [ph]. So printing electronics, we're looking to do some things there. The Press+ acquisition that we made, I mean, investors and newspaper publishers have been sharing the monetization in content that newspaper publishers have enacted and Press+ capabilities helps makes publishers less reliant on volatile advertising. We've seen them grow to 545 affiliates at the end of the third quarter. Nimblefish is becoming a bigger part of our sell process, especially in the financial, health and managed care verticals. Helium's growth in the quarter was good. 8touches is moving out of the Texas market finally and we're starting to gain more business from a national standpoint. LibreDigital is starting to play a bigger role in creating media rich content for our customers for their customers. So I mean, as we sit here today, are we banking on the K-12 textbook market coming back? No, we're not. The states is still in deficit. However, the states, at some point in time, are going to have to update the curriculum that we're teaching to our children. And again, this has got to take place. I do believe there will be physical content that will do that. The next go-around, probably by the end of the decade, they'll probably be electronic, but we'll be there to serve those customers. As you think about the financial arena, the IPOs are picking up from where they were. Last year's numbers for IPOs weren't high, so I mean, we're hoping that we can get over that, as we look at things going into '13 as a turnaround in the economy. But when you have an integrated solution with multiple individual components that allow customers to choose a diverse mix of offering, we should be good. And we touch every part of a communication process that our customers put out to their customers, their shareholders, their employees, their suppliers. We are there for them to serve that. There is no other communication service provider that has the number of services and capabilities that we have. So we're going through the 2013 budget as we sit here today. We think we're taking market share in certain areas. We think we're seeing growth. There's enough print out there that we definitely go after our sales force and say, no matter what, if it's $140 billion in the United States alone, we should be out there and getting our fair share of that. If you cut it in half, it's $70 billion, we still don't have 10% in the United States. I mean, there's opportunities for us out there. We've got to continue to play along the multichannel area for our customers as they go out to reach out to, again, whoever it may be: their employees, their customers, their shareholders, their suppliers. We've got to be able to be there for them for that.

Operator

Our next question comes from Scott Wipperman from Goldman Sachs.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

Dan, I guess, can you first talk about the foreign sub-distribution that you guys are going to get next year? I guess, maybe the timing of the deal, why now, and clarify whether or not you guys are going to have a tax hit for that?

Daniel N. Leib

So we have an intercompany obligation before -- between our foreign sub and the U.S. And as we noted on the schedules, expect $150 million of incremental cash to be paid in 2013 with respect to the obligation. During the third quarter, we made some changes to the capital structure of certain foreign subsidiaries, which resulted in these intercompany obligations. Given that this is related to an intercompany obligation, it's subject to foreign withholding tax in certain countries, and you'll note in the quarter, we recorded an $11 million tax provision related to this.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

And you said you thought you could do this in the future, you expect future repatriation activity?

Daniel N. Leib

So it's an intercompany loan, or rather an intercompany obligation, so there'll be disclosures in the -- additional disclosures in the Q. Yes, there's $150 million in '13 and then there's another -- and these are approximate because it's a euro-denominated obligation for which we've hedged through forwards, but there's an additional $340 million or so in the obligation.

Scott Wipperman - Goldman Sachs Group Inc., Research Division

And then, Tom, just any early thoughts on how the proposed JV of Penguin and Random House could impact the trade book market and, I guess, any help you could provide us just in terms of sizing your exposure there?

Thomas J. Quinlan

Yes, sure. I mean, let me go back to just carry on to what Dan said about your previous question. We've got a good capital structure as far as -- you talked about the credit facility. We've got no debt that matures until 2014 and it's not a big slug that's coming due then. So we've set this up so that, again, no matter which way the economy is going, we're not going to be hit because of the way we've set up the capital structure going forward. And obviously, Dan's looking to use the balance sheet even better than what we have been using it, and we think we've got an opportunity there in 2013. As far as the combinations that are taking place, not only in the book market but across all industries, as people start to get bigger, someone like us who has scale and size, it's a benefit for us as these acquisitions start to take place. So when you see publishers starting to get together, when you see Fortune 500, Fortune 100 companies start to get together, they're going to look for synergies, they're going to look for someone who can bring the power of their platform to them so that they can benefit from them. When these acquisitions are put together, as each one of you know, there is a big part that are carried [ph] about on cost synergies in addition to revenue synergies. They want to get the cost synergies out first. Again, I think that bodes well for us. Particularly for those 2 companies getting together, again, I think the book market as you see out there today is -- continues to evolve. And the thing I like about RR Donnelley's position is that we can handle warehousing, distribution from a physical standpoint, from an electronic standpoint. Those things, to me, are going to be critical to our customers' success as they look to get together.

Operator

Our next question comes from Kannan Venkateshwar from Barclays.

Kannan Venkateshwar - Barclays Capital, Research Division

The first question I have is on the cost front. The benefit we've been seeing over the course of this year has partly been on account of pension cost reduction, and that, I guess, had slowed fees in the pension plan last year. So going forward into next year, I guess the effect of this should fade off, right? And therefore, we should see the costs going up or at least staying where they are right now. So could you help in that?

Thomas J. Quinlan

Sure, I will and then Dan will jump in there. Look, we've been -- for those of you who have been around for a long time, you know this industry is about continuing to improve, continuing to operate in a more efficient manner. Technology helps us get there. I think a lot of you might have been skeptical back in the 2007, 2008, 2009 period, but we showed you then how we can continue to make our platform more efficient so that we can continue to serve our customers and continue to grow. And no matter whether it's pension or manufacturing materials, we get hit with that every day. So we know that and we know that going through in the process, so we will -- as we've done in the past, we'll make our platform more efficient to operate and be able to go ahead and hit our targets that we tell you we're going to go ahead and hit.

Daniel N. Leib

Yes, regarding pension, we don't expect, and these are estimates based on discount rates and the like on the expense side, don't expect much change of this year to next year, so '12 to '13. As I mentioned in the prepared remarks, we do expect the cash side to be about $110 million less in 2013 than 2012, and some of that a result of recent legislation that's been passed.

Operator

Our next question comes from Dan Leben from Robert W. Baird & Co.

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

Two questions, just on the cost side. The first one is just on the -- following up on corporate, big step down sequentially this quarter but the guidance for that to step back up. Any kind of reversals related to pension changes or LIFO or whatnot? Just help us understand why that came down so much. And secondly, longer term, if you look out in some of these markets that are secularly challenged, we've talked a lot about books, is there any evolution in your thought process to how to manage capacity longer-term and when some of those potential actions may take place?

Daniel N. Leib

Sure, yes. I'll take the first part of it. I think Tom would like to address some of the latter part. But relative to corporate, we mentioned the LIFO adjustment, we have an annual adjustment in our workers' comp which took place last year in the third quarter as well. Given our focus on safety and success rate there, that number has been coming down year over year or I should say, year after year.

Thomas J. Quinlan

From the books standpoint, as you look across our platform, there are opportunities there if we need to take those opportunities from a capacity standpoint. So as the previous caller, Kannan, talked about costs, there's opportunities there to go ahead and do that. As we sit here today, I still believe that we want to keep that capacity out there as we go through 2013 and 2014. I think one interesting thing is, if you look at retail inserts in the marketplace, they moved into the fourth quarter and there's pretty good, what I'll say, use of capacity in the fourth quarter for those right now. So there's a product that's going well. When you think about one-color books and all the authors that came out this fall that took place, quite frankly, there wasn't enough capacity from a physical distribution standpoint. So there is still a need for the product, there is still a call. We work with our customers hand-in-hand to make sure that we're able to be there for them and serve them. And when we see that things are evolving, we try to get ahead of them as we've shown you, particularly this year in what's gone on, and we plan to make the same -- take the same actions in the future.

Operator

Our next question comes from Joe Rodbard from Providence.

Joseph S. Rodbard - Providence Equity Partners LLC

Another great job on corporate reduction this quarter. Just hoping you could share with us the year-over-year change in incentive comp.

Daniel N. Leib

Yes, we can do that. So I think we've given some of the numbers historically here, but the year-over-year change is roughly $30 million.

Joseph S. Rodbard - Providence Equity Partners LLC

That was for Q3 or year-to-date?

Daniel N. Leib

That was just the quarter.

Thomas J. Quinlan

And understand on incentive comp for us, as we go through, as we manage this business, and most of you know this, but when our stakeholders win, our employees win. And as we manage the business, when we're not getting to the targets that we've got to get to, then we take the appropriate actions. It's not something that we'd love to do, but it's money that we've earned that we're looking to go ahead and compensate our employees with for the particular time period in question. When those targets are made, then everybody has a good day. And when they're not, we've got to play back on that. So that's how we've managed the business since we've gotten here and that's how we'll continue to manage the business.

Joseph S. Rodbard - Providence Equity Partners LLC

So when we adjust for the lower incentive comp and for the year-over-year change in GAAP pension, 2012 is actually a pretty challenged year. Conceptually, should we think about next year as being maybe a little bit closer to flattish?

Daniel N. Leib

Clearly, we'll come out in February and give our view on 2013 as we normally do. There's a lot that Tom has talked on previous discussions and today as well, of some of the wins that we've had. And so, it's a mix of information. Obviously, capital markets play into it as well. And so we'll come back in February and give a more specific view and go from there.

Thomas J. Quinlan

I don't think when taxes are up as they're up this year, I'm not asking you to forgive me because I've got a high tax rate or asking for excuses there. I mean, when we go through the beginning of the year, we come back and share with you what I think our guidance is going to be for the year and we get there. However which way we need to, we know we've got to manage costs to match revenues and we do that. We know we had some upside from pensions going into this year so that allowed us maybe not to take certain cost actions that we would have taken otherwise. So I think that's how we manage the business on an everyday basis.

Daniel N. Leib

Operator, we have time for one more, please.

Operator

Our final question comes from David Hubert [ph] from Wells Fargo.

Unknown Analyst

I just wanted to focus quickly on the seasonal cash flow. I believe that guidance was given $440 million in Q4, is that -- did I understand that correctly?

Daniel N. Leib

Yes.

Unknown Analyst

Can you take me through the building blocks on that? Is it mostly working capital related, in addition to, I guess, your normal operating income?

Daniel N. Leib

Yes, as we stated, so it would have been in the prepared remarks, the biggest piece of that is working capital, consistent with what we saw in last year's fourth quarter. So the seasonality of the business, right? So use of working capital and many of the offerings earlier in the year and then some of the businesses released working capital into the back half.

Unknown Analyst

Okay. Just wanted to make sure I understood that correctly. And then the $150 million that's, I guess, coming back to the U.S. next year, would you anticipate repaying debt with that? Is that what it's earmarked for or is it kind of TBD?

Daniel N. Leib

Yes, well, as we mentioned, at the end of the third quarter, we had $344 million drawn under the revolver, given the comments on working capital and being a use in Q1 and earlier in the year, would expect to have some amount drawn that could be paid back as that cash came back.

Thomas J. Quinlan

And don't forget, I mean, we're still -- it's usually a question that's asked every call, we're still looking to be in the range, as Dan said earlier, of 2.5x to 3x levered by the end of this year, and that's going to continue to be our guideline as we see 2013 unfolding.

Thank you. Operator, thank you for your assistance. Everybody, appreciate you joining the call today. I know some of you, from what I understand, are dialing in from remote locations, appreciate that, and wish that everybody back in the New York area impacted by this gets back to normal as quickly as possible. Thank you.

Daniel N. Leib

Thank you.

Operator

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

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Source: R.R. Donnelley & Sons Management Discusses Q3 2012 Results - Earnings Call Transcript

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