R.R. Donnelley & Sons Company Presents at Bank of America Merrill Lynch Leveraged Finance Conference, Dec-01-2011 04:10 PM

| About: R.R. Donnelley (RRD)
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R.R. Donnelley & Sons Company (NASDAQ:RRD) December 1, 2011 4:10 PM ET


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


Unknown Analyst

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Moving right ahead. Good afternoon. I'm Stephen Weiss, the high yield cable media analyst at the Bank of America Merrill Lynch. And I'm very pleased to welcome RR Donnelley to the firm's annual leverage finance conference here in Orlando.

With us from the company today, we have a Dan Leib, Chief Financial Officer; Janet Halpin, company's Treasurer; as well as Dave Gardella, Senior Vice President of Finance.

And with that, I'm going to turn the podium over to Dan.

Daniel N. Leib

Thank you. And thank you for joining us this afternoon. We know you have plenty of other things to do and other opportunities to look at, so we do appreciate you spending time with us.

We have few a slides here that we'll go through, and we'll leave some time for Q&A as well. So Slide 2, Safe Harbor language. I leave this to you to read at your leisure. We have all of these on our website as well.

Moving to Slide 3. So Donnelley, largest leading global provider of integrated communications. We are a 147-year-old company, 59,000 employees worldwide. We're in 37 countries, 14 time zones. So at any time of the day or night something is going on in our facilities and in our service centers.

We have, importantly, on the right-hand side, 60,000 customers. And you can see the breakdown of how many customers we're serving, with over $100 million in revenue and how much over 1 million. We do business with 100% of the Fortune 1000 -- or rather Fortune 100, and 88% of the Fortune 1000. And the key takeaway -- and we'll jump into some of the different product lines in which we serve these customers.

Key takeaway is everything we do for our customers was something that our customers formerly did for themselves. And so we see this as a continuing opportunity for us. And we see this in our service offerings, and we'll go into our pie chart. We do report our earnings in terms of service -- or rather our results in terms of service and product.

But you see an increasing level of the company generating earnings from services, and the positive news there is as you look at our capital requirements in the company, they are decreasing. So we would expect, on a go-forward basis, to need to put capital expense in the business at a rate of about 2% to 2.25% of revenue, on a go-forward basis.

These customers here and it's a couple of some examples so obviously, large in -- with the publishing set in magazines, catalogs, retail and search books and directories. And as we have discussions with those customers, we have the ability to bring in our other products and services. We'll show a slide of where we're serving our customers for 6 or more products all the way to 10 or more products. And interestingly enough, we'll show another slide that will show we're the only provider that can have those discussions, and those are productive discussions for us and for our customers. We help them make their supply chain more efficient.

The other thing that you may have read about Donnelley recently is we've purchased a couple of, small for us, but meaningful packaging and labels companies. And that comes purely out of the customer demand to Donnelley to provide those services. And we find that coming out of our global print management initiative, we find where we're sourcing on our customers' behalf and where we're doing that, and then we have the opportunity to make the decision of whether we continue to source on their behalf or whether we should own that capability.

One of the very nice things about our RR Donnelley is our consistent cash flow. This slide, the yellow bar is cash flow from operations, and the blue bar is free cash flow or cash flow from operations less CapEx. You can see that over the period from 2004 through this year. Our expectation this year is that we'll generate $600 million of free cash flow. And over this period, we've generated an average of $574 million of free cash flow.

We have normalized 2009, which has a couple of one-time positive items for free cash. And to my earlier comment that the business is becoming less capital intensive, you can see that in the spread between the yellow bars and the blue bars.

Other key takeaway here is that we've done it in very good economic times, and we've done it in very tough economic times. So our ability to generate the $600 million of free cash flow is a confidence that we have in both good and bad times. And the model we think about is an incremental -- as we've variablized the business, an incremental or decremental margin of approximately 25%.

If you tax effect that and let's take the down case, so $0.25 on the $1. If I lose $1 of revenue, I lose $0.25 in the EBITDA. If I tax effect that, I lose $0.15 or so which is also approximately the amount of working capital commitment we have in the business.

So the business has delevered nicely to revenue and has also levered up nicely. The core strategic advantages, again, largest player in the market. We have a very cost-effective platform with resources in China that we use to export to the U.S. and a little bit into Europe and resources in Poland that we used to ship both east and west within Europe.

The breadth and the depth, we'll show that in more detail, and then the financial profile, we've walked through the strong cash flow. We have, as you'll see, no real direct competitors that provide the breadth of product and service that we provide. But as we go head-to-head in some print engagements with the competitive set, we have outgrown the competitive set on a product-by-product basis.

Print industry, and apologize some of those data is a little bit dated, but it was the most recent available. So print industry is very large, $280 billion in the world and that excludes newspaper print, which we don't participate in.

In the U.S., the market, again excluding newspaper print, is about $112 billion. So Donnelley is the largest in both the U.S., and the world has a relatively small share of this market. And the trends, clearly, and I won't spend a ton of time on Slide 7, but the trends clearly favor the large. And that's the trends in consolidation that we see amongst our suppliers set, the trends that we see in consolidation amongst our customers.

And then just the excess capacity in the industry has clearly benefited a consolidation play. We feel very good about the platform that we built on the print side, and we feel very good about our ability to leverage that into growing out the service offerings that we have.

Illustrative slide of just how consolidation has occurred amongst the printers as well as amongst the supplier base. I won't spend much time on this, but suffices to say that having the scale that Donnelley has is a key statistic advantage for us, as we go to negotiate contracts with the supplier base, and we can offer them a volume level and consistency of volume that's very important to them. And this is Slide 9, what I referred to before as just the landscape. The top part of this slide represents the largest printers and that's by revenue. And you can see Donnelley on the left-hand side. The 2 companies next to us are domiciled in Japan. We don't see them in their market, and they don't participate much in our markets. And then it falls off pretty quickly to Quad, at less than half of our size, and Transcontinental, who does most of their business in Canada, some newspaper printing in the United States and then Deluxe and on down.

Interestingly, on the bottom chart what we've tried to do is lay out the services and products that are offering -- offered by the different competitors in the space. And Donnelley, you can see a very wide breadth of products. We also didn’t make an attempt to denote the depth in each of these offerings, but very deep in each of these offerings, as we'll show on a slide coming up and how our diversified revenue is.

And you can see the others that we see and we often see them in one area but not multiple areas. And why that's important is what we're seeing from customers is the desire. If you go to the low end -- the left-hand side and the low value to customers is largely the bid-and-buy process. And that's I have a piece of work I need done, who can give me the lowest price. We feel we compete very well in that environment because of our scale and procurement and the way we manage our platform.

But where we really add the most values is as you move to the lower right-hand side here, where we're providing multiple products to the customer set, where we're, in many cases, becoming their print procurement function and doing that through our custom buy software tool.

And what we have is we have -- we're in with the partner. We have trust in place, and we have a vested interest in making sure this succeeds. And so often times, we're producing the majority of the work on our platform. Once the relationships are established, it takes time. So at times, we're also sourcing some of the products externally, as I mentioned.

So strategic priorities remain unchanged, continue to invest around new product development. We have a very small yet successful group in Grand Island, New York that's developed -- been developing digital print technology for quite a while. We continue to make some targeted M&A opportunities -- or investments rather and particularly or specifically, acquired a company called Press+, which has a payment mechanism to help publishers get paid for their content.

We purchased a company called Helium, which is a content provider. We had a minority investment in the company, had a right of first refusal, gave us an opportunity to go out to the customer base, see how they would use the content that Helium could provide. And given the strong demand for it, we purchased the company.

We also recently purchased the company LibreDigital, which is a conversion company that converts to digital to place content onto e-reader devices. All of these -- so a lot of names mentioned all of these relatively small acquisitions for us, but helpful to broaden up the product offering and helpful to our customers as they look at evolving with the changing media landscape.

Cost control, critically important to us. We are maniacal about making things variable in nature and then maniacal about adjusting the cost base to revenue. Often times, we'll refer to it as about pennies, nickels and dimes, and it really is. And those discussions takes place at high levels of the organization. We need to drive efficiencies throughout our platform, and we need to do that day in and day out. And one of the ways we do that when we talk about capital expenditures and how the platform is becoming less -- or the company is becoming less capital-intensive, one of areas in which we're investing a fair amount of capital is IT, and that will continue. That is a great way for us to drive productivity through the organization, and the other area where we put quite a bit of capital is in the faster growth areas of Asia or specifically China.

Cash flow liquidity. We talked about the $600 million and consistent generation of that. On the debt side, we'll show a maturity profile, but no significant obligations until 2014. We have $159 million coming due in 2012.

CapEx, as I mentioned, 2%, 2.25%, 2.5% of revenue, and M&A, very disciplined approach. As you can see we've -- how we've managed this in the past. And then the dividend, we have quarterly review with our Board of Directors, the dividend of $1.04 a share has remained at a $1.04 since 2004. So it's been a consistent dollar dividend.

Reference before our ability to serve customers are 6 or more products. This chart shows the success that we've had in that area. So 2007, we served 218 of our customers with greater than 6 products and in 2010, 275 customers. Those customers represent about 30% to 40% of our worldwide revenue. So clearly the larger customers fall in these buckets.

And you can see that this chart going to the right here from 7-plus products to 10-plus products. Pretty unique customer relationship to serve them with more than 10 products and services. But this initiative, the global print management can't stress enough, we're out there. Everyday we're broadening the number of customers that we're bringing into the initiative in a controlled pace. It's not for every customer. It requires them to have a certain buying behavior and infrastructure, but it's critically important to us.

Talked about diversity of product. This is a chart that compares us, how we looked in 2000, largely publishing-centric with a financial print business to where we are today. 74% domestic revenue, 26% international and a very diverse offering from tonnage print in the U.S. to transactional print in the U.S. to a core service offering in the U.S. And that in the 26% of revenue, very strong platform and growing in Asia and particularly in China. And in certain Latin American countries, we have a very good position, Mexico, Chile, Brazil to name the most predominant ones.

The variable cost structure. We've been showing this chart for a while now. But I'd mentioned, we've variablized the cost structure. This is what it looked like last year. This is what allows us to stay to a 25% incremental, decremental margin. We have off-shored composition work in some of our business units. We have off-shored back office work where we can. Those in a plant that don't touch a press, we've been making progress in making ourselves more variable-costed in nature. And this has really allowed us to maintain that 25% incremental, decremental margin.

From a liquidity and maturity profile, so we ended the quarter, third quarter, with $370 million of cash. A big part of that is overseas cash. We have a $1,750 billion of a committed credit facility that runs through December -- or into December of 2013, and we had net available liquidity at the end of the third quarter of $1 billion -- just over $1.3 billion.

From a debt maturity profile, I mentioned nothing coming due until 2014. And then you can see the silos as they fan out, and the $159 million come in due in 2012.

From a capital deployment, if you look at what we've done over the past -- as long as I've been here, since 2004, we've had periods in time in which we've been more acquisitive. We've had periods of time in which we've done share repurchases, and we've had periods of time in which we paid down a lot of debt.

And so flexible capital deployment is what we always talk about. We have 2.5x to 3x leverage as our stated goal. We ended the third quarter at 3.1x, and we have gone through with the rating agencies, obviously, in light of the share repurchase that we announced, which I'll talk about in a minute, but which we announced in May.

A number of meetings at the rating agencies. We are currently at BA1 with a stable outlook at Moody's, and we're currently BB+ with a negative outlook at S&P. A recent change they made a couple of days ago was coincident in the day that they downgraded the 37 banks.

We have the ability to reduce our debt as shown by the strong cash flow. We did announce that we would be freezing and closing our United States pension plans effective January 1 of 2012. The dividend, as I mentioned, has been in place same levels since '04. The buyback, as we think about the dividend, the current yield on the dividend is significantly above our after-tax cost of borrowing. So from a trade perspective and we -- this was a capital structure decision. But from a trade perspective, it's cash accretive as we buyback stock and take out the dividend relative to the incremental interest costs. Understand the flexibility argument as it relates to taking on the incremental debt.

Capital. I mentioned becoming less capital-intensive, and the share repurchase, we had announced it in May. We completed the first $500 million in mid-November, and we have a remaining authorization of $500 million that runs through 2012.

Guidance. This was issued on our conference call early November. All consistent with what I've just described in terms of free cash flow at $600 million. The year-over-year revenue was in the range of $10.7 million to $10.8 million, and that's relatively flat when you adjust out the positive impact of FX. We also have pass-through paper which runs through and can impact things positive or negative on the top line, but no impact in the dollar margin rate and target gross leverage as we talked through.

And from a prepared remarks, that's all I have. I want to leave some time for questions. So again, appreciate you taking the time. And open it up for questions now.

Question-and-Answer Session

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Great. Thanks, Dan. Why don't I start you off with 1 or 2? At the end of your presentation, you highlighted some of the factors that influence your reported numbers, acquisitions and currency and pass-through cost, et cetera. Can you just maybe provide a framework for how investors should think about organic growth in this business going forward? And if you can, specifically discuss like how you'd -- the impact of the economy and pricing capacity considerations, as well as the migration to digital which is an ongoing factor into this outlook for the business.

Daniel N. Leib

Yes, sure. Probably and I pulled up Slide 13 here just as reference. At a macro level, the business should perform in line with U.S. GDP. That would -- obviously, we've got a mix here. We've gotten international piece that's been growing at faster than U.S. GDP. We have some of the offerings in tonnage print that have -- as you've mentioned, some secular pressure although, interesting. If you look at our catalog magazine, retail and serve business on, a year-to-date basis through the third quarter, that is, revenue is flat. And so that business has held in well. Book and directory. Directory continues to experience secular decline, and the book business, few different pieces of it, but the textbooks which are contingent on state funding have been under pressure recently. We're predominantly in the elementary and high school textbook business for our textbook business. And Texas did adopt new textbooks this year, Texas and Florida last year. So there'll be some future adoptions there. And when you mix that together with what we're seeing in transactional print, so direct mail and commercial, which are really GDP-driven businesses that coupled with the service businesses which are growing substantially faster than GDP. So logistics business, over the past 7 quarters, has grown organically at 17%. That, combined with international, puts us on an all blended in at approximately the U.S. GDP.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Okay. And then I guess, corollary question just on the margin front. So I guess in 3Q your revenues were up about $195 million year-over-year. The way we calculate your EBITDA, you were kind of flattish more or less, which would imply margins where, I don't know, down about a 100 basis points, call it. Can you just help us create a context for how to think about the margin erosion that you've been enduring in recent times?

Daniel N. Leib

Yes, absolutely. So quick couple of comments. The pricing environment, we get the question often. If we look back to 2004, price has been down across many platforms here, but across the company, 1% to 2%. That's been very consistent throughout that period. We are in the same environment right now, down to 1% to 2%. Incumbent on us to drive cost out of the business. One of the ways we do that is we've centralized scheduling and pricing and that allows us to put the work into the most optimal places, price it appropriately and drive efficiencies. As it relates to the margin, a couple of factors impact margin, one is FX. And so our platform, with operations in China that are exporting and operations in Poland that are exporting, FX has been a large positive on the top line. It's been a negative on the bottom line. So when you take those 2 and adjust for that, that accounts for a piece of the margin degradation. Other piece of it is pass-through paper, which has been up a bit. And the last piece has been Bowne, which was a lower margin business that we acquired. And as we squeeze out the productivity and integration savings there that will be a positive for the year. The impact of Bowne is about 40 basis points negative on the margin. So really, if you take those factors, those more than describe what's going on. Clearly, with an offering this broad, you're going to have positives and negatives. We've been very happy with Bowne from a capital markets perspective in terms of how much work is getting filed on the IPO side and how much of that we're winning. As we all know with what's going on in the IPO market, not a lot of that is getting priced. So that has not come through positively in our numbers yet. And the other area we've been seeing some very good progress is the supply chain and packaging initiatives that we've driven predominantly through our Asia platform, Europe platform and then what we've done domestically particularly with the 2 recent acquisitions.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Great. Let me ask maybe one more on the balance sheet, and then we'll go to the floor. So you've highlighted your targeted range of 2.5 to 3. I guess, you're close to the outer end of that range now. Given the market and where the equities trade in the space, are you continue to be convinced that this is the right area for the company to be in? It's a multipart question, please. How come -- are you seeing teasing the rest of the stock repurchase program through? I know you have another year to act on that. And then my third part to this balance sheet question is just on your debt maturity profile on the slide you had up there. As you go forward, do you see yourself kind of perennially tapping the market? Or would you look to do kind of a more permanent pay-down on your debt to internally drive funds based on your maturity profile?

Daniel N. Leib

Yes, sure. So first on the leverage target, I spend a lot of time with the management team and the board in coming up with what we thought at the right time and believe to be the right capital structure for the company at 2.5x to 3x leverage. And that's where we arrive the trade of doing the buyback was not a trade, it was a capital structure decision. So the first $500 million is complete. The second $500 million, we have authorization. We've obviously not made any announcements about what we may or may not be doing. But I would tell you everything is guided by the guidepost of the 2.5x to 3x and so feel good about that. In terms of the profile, as you look at the maturity profile and if you layer in an expectation on the cash-generating ability of the business, we feel very good about this capital structure. We feel very good about the liquidity that we have available to us. We are always looking at the market. We did, in May, the issuance that we slotted in, in 2018, was an issuance and a tender. And we're constantly looking at the market to make sure that at all points in time, we look at our maturity profile and feel as good as we do about it today.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

And the only thing that I add is that last part. Was your free cash flow seems to more or less accommodate your maturities from here forward?

Daniel N. Leib

Yes, that's exactly right. I mean, you can look at a couple of the higher towers, and if you look at it on an after-dividend basis, there's a little bit of a gap, but not much. And we have obviously managed it accordingly.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Anything from the floor?

Unknown Analyst

I guess, still on the share repurchase, the continued authorization. How much do ratings impact your decision whether to go forward on that? Are you trying to protect that S&P rating? Or are you operating kind of outside of that?

Daniel N. Leib

Yes, it's a good question. We feel very protective of our ratings. Having said that, we've recognized that it's not something that we determine. So we have spent a lot of time with the agencies in informing them and sharing with them our plans and really informing them about our business. At the -- having said that, the 2.5 to 3 is what we've stated, and so they're the ones whose role it is to rate the company in light of those metrics. But we haven't changed off those metrics.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

We've got another minute or so. We have nothing from the floor. I'll ask. I know you did some bond purchases on the open market last quarter. I think you disclosed. Can you just talk about your ability or inclination to pursue those going forward?

Daniel N. Leib

Sure, yes. As I mentioned, we did a larger tender in conjunction with an offering in May. Last quarter, we bought low teens of the 2019s, and we're -- as I mentioned, we're always looking at the market. We would love to hear about opportunities to repurchase our bonds at the appropriate or at attractive rates for us. And so as those present themselves, we evaluate them one by one. But we haven't been out actively targeting any particular maturity.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

And this is effectively the way your balance sheet is set up is really not too many restrictions on how you can do that?

Daniel N. Leib

That's correct. Absolutely.

Stephen W. Weiss - BofA Merrill Lynch, Research Division

Right on queue. How about that? Thank you very much for coming, and hope to have you back next year.

Daniel N. Leib

Great. Thank you.

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